This paper focuses on the most recent revisions, introduced in December 2015 by the
updated consultative paper,to the standardised treatment of public sector entities (PSEs).In
doing so, this paper, analysing the currentregulatory proposals, tests the hypothesis stating
that the affected banks may experience higher or lower capital charges for credit risk
depending on the followingfactors:
choosing the optimal risk weight calculation methodology; and
choosing the optimal composition of the credit risk portfolio.
Banks and other credit institutionsshould understand that the aforementionedfactors affect
Relationship Managers and their preferences for lending to speciﬁc obligors as well as
Credit Risk Analysts and their preferences for the regulatory prescribed methodologies for
calculating credit risk weights. Ultimately, the amount of capital charge depends on smart
choices made by industry practitioners.
First, focusing on the changing regulatory background, this paper aims to explain the
proposed revisions to the standardisedapproach for credit risk. The paper limits its scope to
discussing the regulatoryimplications for the standardised treatment of PSEs, as other asset
classes will be discussed and empiricallytested in forthcoming studies. This paper analyses
the proposed regulatory changes to ﬁnd out whether the new standards for calculating
speciﬁc risk weights for PSEs under the standardised approach for credit risk are clear,
consistent and result in the overall improvement of risk management. Where necessary,
upon the review of the forthcoming standards, this paper attempts to indicate room for
improvement for policymakers and ﬂag areas of potential ambiguity for practitioners. One
should note that the Basel Committeewill conduct a qualitative impact study in the future to
highlight any room for improvementand further amend the proposed regulations. With this
in mind, the paper aims to support the future studyconducted by the Basel Committee with
Second, focusing on delivering practical implications, this paper attempts to show
optimal ways of calculatingrisk weights for PSEs under the standardisedapproach in credit
risk. In the second consultativepaper, the Basel Committee has proposed two methodologies
for calculating credit risk weights with respect to PSEs and agreed that certain PSEs can
received the sametreatment as sovereign exposures:
bank can map PSEs’risk weights to the sovereign rating;
bank can map PSEs’risk weights to the speciﬁc rating of an entity; and
bank can treat certain PSEs as sovereign exposures.
Against this backdrop, an optimal solution for the standardised treatment of public sector
entities is sketched in this paper. Thus, industry practitioners can beneﬁt from achieving
lower capital charges while maintainingthe appropriate level of conservatism. All in all, the
research questionsattempted in this paper boil down to resolving the followingissues:
RQ1. What needs to be improved in the revised standards for the standardised
approach to PSEs?
RQ2. What is the optimal solutionto calculating risk weights for PSEs?
RQ3. What are the criteria fora PSE to be treated as a sovereign exposure?
The current paper is organised as follows. The next section (Section 2) discusses and
analyses the revised standards for the standardised approach in credit risk with respect to
the treatment of PSEs. This section highlightskey challenges, ﬂaws and implications of the