Changes in the Standardized Approach (STA) for Credit Risk Arising from CRR 3

Newsletter 09/2024

The new CRR 3 regulation (Regulation EU 2024/1623) brings a significant number of changes, including in the area of credit risk (CR). In this article, we summarize the changes related to the STA for calculating the capital requirement for CR. Due to CRR 3, which also introduces output floor, the capital requirement for CR under STA will need to be calculated by every institution, including those currently using the advanced approach (IRB).

Basel III introduced changes in the STA primarily to increase the sensitivity of this approach to risk and to bring it closer to the IRB approach. The aim was also to maintain the simplicity and universality of the STA. However, compared to Basel III, CRR 3 contains additional exemptions, requirements, and transitional provisions that complicate this simplicity.

The following main changes occur within the STA:

• There is an adjustment of risk weights (RW) in almost all exposure categories, and in some categories, additional subdivisions are made according to the level of credit risk (CR):
  • For exposures to unrated institutions, institutions are divided into three tiers (A, B, and C). The exact rules for assigning institutions to tiers A, B, and C based on riskiness are not provided, and institutions must create their own methodology.
  • For corporate exposures, a subcategory of specialized lending exposures is created, which is further divided into project finance, object finance, and commodity finance.
  • For retail exposures, a preferential RW is introduced for transactor exposures, while a higher RW is applied in cases of currency mismatches.
  • For equity exposures, they are divided into several groups, with RW ranging from 0% to 400%.
• The changes in exposures secured by real estate are the most extensive:
  • The source of loan repayment, whether the property is completed, still under construction, or in preparation for construction, is considered. RW now significantly depends on the ratio of the property value to the size of the exposure (loan). At the same time, preferential conditions are defined, which lead to lower RWs.
  • The requirements for property valuation are adjusted. When valuing, prudently conservative criteria should be applied, where:
    • The value of the property does not include expected price increases, and
    • The value of the property is adjusted to reflect the possibility that the current market price is significantly higher than a value sustainable over the life of the loan.
  • In the case of property revaluation, the value must not exceed the higher of:
    • the average value measured for this property or comparable property over the last 6 years for residential property (8 years for commercial property), or
    • the value at the time the loan was granted.
  • Regarding property value monitoring:
    • the requirements for the frequency of monitoring property value remain unchanged;
    • new ESG-related restrictions are now also an indication of property value decline, and
    • requirements for models used to monitor property value have been newly introduced.
• The credit conversion factors (CCF) for off-balance sheet exposures are adjusted. Exposures are now divided into 5 buckets, with even the least risky bucket having a non-zero CCF.

 
CRR 3 contains many transitional provisions. The most important of these include measures allowing:

• for exposures that arose before the effective date of CRR 3, to continue valuing real estate using the current approach until the property value needs to be reviewed or until 31. 12. 2027, whichever comes first;
• the impact of changes to be spread over several years (for example, the gradual increase of CCF for off-balance sheet exposures that previously had an CCF of 0%, or for equity exposures that will now have an RW of 250% and 400%);
• for IRB institutions that, due to the output floor, will now be required to also calculate the capital requirement under STA, the ability to:
  • use lower RW in STA for selected corporate exposures;
  • gradually increase RW for selected exposures secured by residential property; and
  • use an alternative calculation of risk-weighted assets for equity exposures until 31. 12. 2029.

 
The CRR 3 regulation, and thus the changes described above, will be effective from 1. 1. 2025. The time for implementing the changes is therefore running out.
 
Furthermore, during the implementation of regulatory changes related to STA, we can offer you for example the following:

• a workshop where we will familiarize participants with the changes in regulation,
• conducting a gap analysis and proposing a roadmap for the implementation of changes,
• designing/validating an internal methodology for the implementation of STA in banks that use IRB,
• creating/validating a tool for calculating capital requirements according to STA, and
• consulting on the implementation of specific changes (including adjustments to methodologies and models).