On March 24, 2016, the Basel Committee on Banking Supervision released a consultative document entitled “Reducing Variation in Credit Risk-Weighted Assets – Constraints on the Use of Internal Model Approaches”, setting forth proposed changes to the advanced internal ratings based approach as well as the foundation internal ratings based approach. Under the IRB approaches, banks are permitted to use internal models to determine their regulatory capital requirements for credit risk. The proposed changes to the IRB approaches include (i) removing the option to use the IRB approaches for certain exposure categories (banks and other financial institutions, including insurance companies; large corporates; equities; and specialized lending that use banks’ estimates of model parameters); (ii) adopting certain parameters to ensure a minimum level of conservatism for portfolios utilizing the IRB approaches; and (iii) providing greater specification of parameter estimation practices. Other proposals include, for example, changes to the credit risk mitigation haircuts for nonfinancial collateral under the foundation IRB approach. The proposed changes to the IRB approaches form a key element of the overall regulatory reform program that the Basel Committee hopes to finalize by year-end 2016, with the ultimate aim to: (i) reduce the complexity of the regulatory framework and improve comparability across banks; and (ii) address undue variability in the capital requirements for credit risk. The Basel Committee noted that the treatment of sovereign exposures is subject to ongoing review. Comments on the consultation are due by June 24, 2016.

In another model-related action, the Basel Committee noted that it was eliminating the proposed internal model approach to the proposed framework for credit valuation adjustment risk.

The full text of the Basel Committee consultative document is available at: http://www.bis.org/bcbs/publ/d362.pdf