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This chapter addresses the prudential treatment of securitisation transactions. It focuses on the various facets of the prudential treatment from a perspective of European regulated credit institutions in the various roles and capacities banks may play or assume in securitisation transactions. Firstly, for banks acting as originator or original lender, provided strict conditions are met, a securitisation transaction may result in an off-balance sheet treatment for prudential purposes, in other words assets forming part of the securitisation transaction are no longer part of the assets held by banks for which risk weights must be calculated. Secondly, from the perspective of banks investing in securitisation positions, such positions may obtain lower risk weights if they meet certain conditions. Thirdly, banks may act as sponsor in connection with Asset Backed Commercial Paper (ABCP) transactions, therefore fulfilling a pivotal role in managing the liquidity of the ABCP conduit. Finally, securitisation positions held by banks within the treasury function may be comprised in the liquidity buffer in order to meet the liquidity management rules. The chapter looks at the development of the regulatory framework for securitisations in the Basel Committee on Banking Supervision (BCBS), as well as the adoption of the Basel capital standards and the Significant Risk Transfer (SRT) rules in Europe.

This chapter focuses on the total risk exposure amount (TREA) and on the leverage ratio (LR). It begins by introducing the different concepts of an institution’s capital, before discussing the TREA in the Capital Requirements Regulation (CRR), including the most significant changes introduced by the CRR II. The chapter then analyses the relationship between the TREA and the different additional buffer requirements set out in the fourth Capital Requirements Directive (CRD IV). The TREA is also the denominator of the ratios of these different additional buffers. Finally, the chapter looks into the LR. Contrarily to the capital ratio, the LR is a non-risk weighted capital measure. The binding LR which requires institutions to maintain at least Tier 1 (T1) capital of 3% of their non-risk weighted assets is a new ratio introduced by CRR II. An additional ratio will apply for global systemic important institutions (G-SIIs).

This chapter traces the evolution of the Basel Committee on Banking Supervision (BCBS) standards in respect of credit risk. The First Basel Capital Accord of 1988 (Basel I) introduces uniform rules for the minimum capital that banks must hold in light of the risks that banks run in the credit business. Basel II codifies a number of rules that had been adopted since the adoption of Basel I in 1988. With regard to the weighting of the credit risk for (on) balance sheet items, banks can apply two methods, the Standard approach (SA) and the internal models method (Internal Ratings-Based Approach, ‘IRB’). The original foundations of the SA as laid down in Basel I of 1988 underpinned the risk weighting of credit risk exposures for about 30 years. However, the fundamental turn in the approach to risk weighting of the various exposure classes as a result of Basel III-Reform brought about major changes for European banks applying the SA. No less fundamental are the changes introduced for banks applying the IRB approach as a result of Basel III-Reform.

This chapter assesses credit risk mitigation (CRM) techniques and credit risk protection. Managing the risk of default of bank counterparties is, if possible, the most important objective of banks engaged in lending. The lower the counterparty’s creditworthiness, the stronger the collateral must be for a bank to be prepared to extend its credit. From the perspective of prudential supervision, CRM techniques will be subjected to an in-depth test to determine whether the reduction in credit risk envisaged by the bank may actually lead to a reduction in the weighting of the credit risk on the item concerned for the purpose of capital adequacy. Each bank applies its own techniques and terms and conditions related to lending and credit risk management; this is how banks distinguish themselves from each other. The chapter then looks at the developments in the regulation of CRM in the Basel standards or in Capital Requirements Regulation (CRR), considering the genesis of the rules regarding capital market-driven CRM techniques and the use of financial collateral. It also identifies the general principles of CRM and of funded and unfunded credit protection.

This chapter evaluates the principles for assessing credit risk, the consequences this has for capital requirements, and the fundamental approach that is chosen for all banks in this area. Absorbing losses is one of the functions of bank capital. As regards the credit risk concerning the bank’s exposures, it can generally be argued that banks will suffer losses on their credit portfolios due to counterparties failing to pay interest, the principal or costs incurred by the bank and attributable to the relevant loans. Banks will by nature always be faced with such losses, the only question of when they will occur, and their magnitude is an issue that will have to be dealt with in the context of credit risk management. The chapter then differentiates between manifest losses, expected losses, and unexpected losses. It also looks at the capital conservation buffer (CCB) introduced by Basel III; the definition of default in European banking law; and credit risk adjustments. Finally, the chapter considers the revisions to Capital Requirements Regulation (CRR) to address non-performing exposures.

This chapter explores funded credit protection in the form of netting and financial collateral. It looks at the relationship between the specific credit risk mitigation (CRM) rules discussed in Chapter Eight and the legal or private law concepts that form the background of the CRM rules for netting and financial collateral. All CRM rules assume that under the relevant private law(s), the ‘credit protection arrangement’ that is envisaged to result in ‘credit risk mitigation’, be ‘legally effective and enforceable’. Where the Capital Requirements Regulation (CRR) requires CRM arrangements to be ‘legally effective and enforceable’, an important issue is whether netting can be effectuated when need be, i.e. in the event of a default by the counterparty of the relevant institution. Especially applicable insolvency laws may limit this ability. The chapter then considers how there is a strong fragmentation of the rules for netting within the CRR framework.

This chapter studies the capital requirements for operational risk, which were included for the first time in the Basel Accord of 2004. Because the effects of operational risk can be vast, it is important that banks have sound risk management policies and risk assessment procedures to address this particular risk family. In the last two decades, the Basel Committee of Banking and Supervision (BCBS) has put up important frameworks, which are implemented in legislation of the European Union (EU), most importantly in the Capital Requirements Regulation (CRR). Currently, the CRR provides four possible approaches (or methodologies) to calculate the own funds requirements for operational risk: the Basis Indicator Approach (BIA), the Standardised Approach (SA), the Alternative Standardised Approach (ASA), and the Advanced Measurement Approach (AMA). However, the current framework will be overhauled by a new framework which should apply from January of 2022: the Basel III-Reform. This will implement the revised standards as adopted by the BCBS in December of 2017. The chapter looks at the new framework and its new approach on operational risk, before considering disclosure requirements and the principles for sound management of operational risk.