weight. Thus, the risk weights for option 2 shown in the heading in Exhibit 3.3 per-
tain to the bank’scredit rating. For example, a bank with an AAA rating would re-
ceive a 20% risk weight (and a 1.6% capital requirement) no matter what the sover-
eign’s credit rating. Exhibit 3.3 also shows that BIS II reduced the risk weights for
all bank claims with original maturity of three months or less.^22 The choice of which
option applies is left to national bank regulators and must be uniformly adopted for
all banks in the country.
3.3 ASSESSMENT. BIS II is a step in the right direction in that it adds risk sensitiv-
ity to the regulatory treatment of capital requirements to absorb credit losses. How-
ever, Altman and Saunders (2001a, b) and the Institute of International Finance
(2000) find insufficient risk sensitivity in the proposed risk buckets of the Standard-
ized Model, especially in the lowest-rated bucket for corporates (rated below BB-),
which will require a risk weight three times greater than proposed under BIS II to
cover unexpected losses based on empirical evidence on corporate bond loss data.^23
By contrast, the risk weight in the first two corporate loan buckets may be too high.
Exhibit 3.4 shows the historical actual one year losses on a bond portfolio using a
loss distribution (default mode) at the 99.97% confidence level (i.e., credit losses will
exceed the capital amounts as a percent of assests (loans) shown in Exhibit 3.4 in just
three out of 10,000 years).^24 The 1.6% capital charge for the first risk bucket (AAA
to AA-ratings) is too high given the 0% historical loss experience. However, the his-
torical one-year loss experience for the lowest-risk bucket (ratings below BB-) is sig-
nificantly larger than the 12% capital requirement. Thus, capital regulation arbitrage
incentives will not be completely eliminated by the BIS II credit risk weights.^25
The unrated risk bucket (of 100%) has also been criticized (see Altman and Saun-
ders (2001a, b)). Exhibit 3.5 shows that more than 70% of corporate exposures were
unrated in the 138 banks that participated in a BIS survey (the Quantitative Impact
3.3 ASSESSMENT 3 • 7AAA to AA– A+ to A– BBB+ to BB– Below BB–BIS II Risk Weight 20% 50% 100% 150%
BIS II Capital Requirement 1.6% 4% 8% 12%
All Bonds 1981–1999 0% 14.988% 54.837% 97.228%
Senior Bonds 1981–1999 0% 0% 91.862% 93.185%
All Bonds 1981–2000 0% 14.989% 74.749% 97.309%
Year 2000 0% 0% 91.187% 93.762%
Source:Altman and Saunders (2001b)
Exhibit 3.4. Comparison of BIS II Proposed Risk Buckets to Actual Loss Values
(^22) However, if the contract is expected to roll over upon maturity (e.g., an open repo), then its effec-
tive maturity exceeds three months and the bank supervisor may consider it ineligible for the preferen-
tial risk weights shown in Exhibit 3.3.
(^23) Similary, Powell (2001) finds insufficient convexity in the Standarized Approach for sovereign debt.
(^24) It should be noted that since actual loss data are used and the samples are finite, there are standard
errors around these estimates. Moreover, BIS II is calibrated to a 99.9% level, not the higher 99.97% used
in the Altman and Saunders (2001b) study.
(^25) One year has become the common time horizon for credit risk models since one year is perceived
as being of sufficient length for a bank to raise additional capital (if able to do so). However, Carey
(2001b) contends that this time horizon is too short.