HSBC 2009 Annual Report Download - page 289

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differs from that used for regulatory purposes.
Investments in banking associates, which are equity
accounted in the financial accounting consolidation,
are proportionally consolidated for regulatory
purposes. Subsidiaries and associates engaged in
insurance and non-financial activities are excluded
from the regulatory consolidation and are deducted
from regulatory capital. The regulatory consolidation
does not include SPEs where significant risk has
been transferred to third parties. Exposures to these
SPEs are risk-weighted as securitisation positions for
regulatory purposes.
Pillar 1
Pillar 1 covers the capital resources requirements for
credit risk, market risk and operational risk. Credit
risk also covers both counterparty credit risk and
securitisation requirements. All these requirements
are expressed in terms of risk-weighted assets
(‘RWA’s).
Credit risk
Basel II provides three approaches of increasing
sophistication to the calculation of pillar 1 credit
risk capital requirements. The most basic, the
standardised approach, requires banks to use external
credit ratings to determine the risk weightings
applied to rated counterparties and group other
counterparties into broad categories and apply
standardised risk weightings to these categories.
The next level, the internal ratings-based (‘IRB’)
foundation approach, allows banks to calculate their
credit risk capital requirements on the basis of their
internal assessment of the probability that a
counterparty will default (‘PD’), but subjects their
quantified estimates of exposure at default (‘EAD’)
and loss given default (‘LGD’) to standard
supervisory parameters. Finally, the IRB advanced
approach allows banks to use their own internal
assessment in both determining PD and quantifying
EAD and LGD.
The capital resources requirement, which is
intended to cover unexpected losses, is derived from
a formula specified in the regulatory rules, which
incorporates these factors and other variables such as
maturity and correlation. Expected losses under the
IRB approaches are calculated by multiplying PD by
EAD and LGD. Expected losses are deducted from
capital to the extent that they exceed accounting
impairment allowances.
For credit risk, with the FSA’s approval, HSBC
has adopted the IRB advanced approach for the
majority of its business, with the remainder on either
IRB foundation or standardised approaches.
For consolidated group reporting, the FSA’s
rules permit the use of other regulators’ standardised
approaches where they are considered equivalent.
The use of other regulators’ IRB approaches is
subject to the agreement of the FSA. Under the
Group’s Basel II rollout plans, a number of Group
companies are in transition to advanced IRB
approaches. At December 2009, corporate portfolios
in France, Hong Kong and Rest of Asia- Pacific
completed the transition from foundation to
advanced IRB approaches. Other Group companies
and portfolios remain on the standardised or
foundation approaches under Basel II, pending
definition of local regulations or model approval, or
under exemptions from IRB treatment.
Counterparty credit risk
Counterparty credit risk in both the trading and non-
trading books is the risk that the counterparty to a
transaction may default before completing the
satisfactory settlement of the transaction. Three
approaches to calculating counterparty credit risk
and determining exposure values are defined by
Basel II: standardised, mark-to-market and internal
model method. These exposure values are used to
determine capital requirements under one of the
credit risk approaches; standardised, IRB foundation
and IRB advanced.
HSBC uses the mark-to-market and internal
model method approaches for counterparty credit
risk. Its longer-term aim is to migrate more positions
from the mark-to-market to the internal model
method approach.
Securitisation
Basel II specifies two methods for calculating credit
risk requirements for securitisation positions in the
non-trading book, being the standardised and IRB
approaches. Both approaches rely on the mapping
of rating agency credit ratings to risk weights,
which range between 7 per cent and 1,250 per cent.
Positions that would otherwise be weighted at
1,250 per cent are deducted from capital. Within
the IRB approach, HSBC uses the Ratings Based
Method for the majority of its non-trading book
securitisation positions, and the Internal Assessment
Approach for unrated liquidity facilities and
programme wide enhancements for asset-backed
securitisations.
HSBC uses the IRB approach for the majority of
its non-trading book securitisation positions, while
those in the trading book are treated like other
market risk positions.