European Commission proposals published in October 2021 have significant implications for credit risk and the “aggregate output floor”. This has been a contentious area since the Basel guidelines were updated in 2017, with market participants warning that the higher risk weights for high quality unrated corporates – which crucially includes funds – will lead to a dramatic increase in bank capital requirements and a reduction in lending.
Under the pending Basel rules, high quality credits with no external rating will be assigned a risk weight of 100% – a significant jump from the typical range of PD/LGD model-based estimates previously. Currently, the vast majority of corporates along with nearly all of the tens of thousands of high quality funds do not have an external rating; in part due to the cost of retaining a traditional credit rating agency (“CRA”) rating.
Figure 1 shows the proportion of 26,000 EU Corporates and Funds that have a rating from global banks1 but no rating from any of the three major CRAs [please continue below to access full report].
1 Provided by 11 global banks with significant exposure to EU entities (defined as 700 and more entities). The universe breaks down to 34% traditional Corporates and 66% Funds.