3 • 1

CHAPTER

3

BIS BASEL INTERNATIONAL BANK

CAPITAL ACCORDS*

Linda Allen

Baruch College, CUNY

Anthony Saunders

New York University

CONTENTS

3.1 Introduction 1
3.2 Standardized Model for Credit
Risk 4
3.3 Assessment 7
3.4 Internal Ratings–Based Models for
Credit Risk 10
(a) Foundation IRB Approach 11
(b) Advanced IRB Approach 14
3.5 Assessment 16
3.6 Summary 17

APPENDIX A: Mapping of S & P,

Moody’s, and Fitch IBCA Ratings 18

APPENDIX B: BIS II Treatment of

Retail Exposures Under the Internal

Ratings–Based Approach 19

SOURCES AND SUGGESTED

REFERENCES 21

3.1 INTRODUCTION. The 1988 Basel^1 Captial Accord (BIS I) was revolutionary
in that it sought to develop a single capital requirement for credit risk across the
major banking countries of the world.^2 A major focus of BIS I was to distinguish the
credit risk of sovereign, bank, and mortgage obligations (accorded lower risk
weights) from nonbank private sector or commercial loan obligations (accorded the
highest risk weight). There was little or no attempt to differentiate the credit risk ex-
posure within the commercial loan classification. All commercial loans implicitly re-
quired an 8% total capital requirement (Tier 1 plus Tier 2),^3 regardless of the inher-

*This chapter is excerpted from A. Saunders and L. Allen, Credit Risk Measurement: New Approaches
to Value at Risk and Other Paradigms.New York: John Wiley & Sons, Second Edition, 2002.

(^1) The Basel Committee consists of senior supervisory representatives from Belgium, Canada, France,
Germany, Italy, Japan, Luxembourg, Netherlands, Sweden, Switzerland, United Kingdom, and the United
States. It usually meets at the Bank for International Settlements in Basel, where its permanent Secre-
tariat is located.
(^2) More than 100 countries have adopted BIS I.
(^3) Tier 1 consists of the last, residual claims on the bank’s assets, such as common stock and perpetual
preferred stock. Tier 2 capital is slightly more senior than Tier 1, e.g., preferred stock and subordinated debt.