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FRM Exam Part II · Basel III: Finalising Post-crisis Reforms

Basel III Revised Standardised Approach for Credit Risk Explained

Updated 11 October 2026 · Fact-checked

The Basel III revised standardised approach sets credit risk-weighted assets as exposure × risk weight. It makes weights more risk-sensitive: banks and corporates use graded ratings or due diligence, real estate uses loan-to-value buckets, and regulatory retail gets 75%. To solve questions, classify the exposure, convert off-balance-sheet items with a credit conversion factor, apply the weight, and multiply.

Understand Revised Standardised Approach for Credit Risk

Under the standardised approach, a bank does not use its own models to find credit risk capital. It takes each exposure, assigns a risk weight set by the regulator, and multiplies. The result is risk-weighted assets (RWA). Capital ratios are then measured against RWA.

The pre-reform Basel II version was blunt. Most unrated corporates got 100%. Residential mortgages got a flat weight regardless of how large the loan was relative to the house. Bank weights depended heavily on the weight of the bank's home sovereign, or on ratings alone. The crisis showed that this was too crude and relied too much on external ratings.

The revised approach, finalised in the Basel III post-crisis reforms, adds granularity and reduces mechanical reliance on ratings. Banks are split into External Credit Risk Assessment Approach (ECRA) for rated banks and Standardised Credit Risk Assessment Approach (SCRA) for unrated banks. Corporates get a finer ratings scale, with a 75% weight for BBB. Real estate weights now depend on loan-to-value (LTV) and on whether repayment depends materially on the property's cash flows. Credit conversion factors (CCFs) for off-balance-sheet items were also tightened, for example 10% for unconditionally cancellable commitments instead of 0%.

The approach also tightens due diligence. A bank may use external ratings from recognised agencies, but it must still understand the counterparty's risk. If due diligence shows the risk is higher than the rating or weight implies, the bank must apply a higher risk weight. It cannot cherry-pick the most favourable rating.

The revised approach also matters because of the output floor, which sets a minimum on RWA from internal models relative to the standardised result. Better standardised weights therefore affect every bank.

Key formulas to remember

Credit RWA
RWA = EAD × risk weight
EAD is the exposure net of specific provisions, and for off-balance-sheet items is the nominal amount × CCF.
Off-balance-sheet exposure
EAD = notional × CCF
Examples: unconditionally cancellable commitments 10%; other commitments 40%; transaction-related contingencies 50%; trade letters of credit 20%; direct credit substitutes 100%.
Loan-to-value
LTV = loan amount ÷ property value
For the bucket tables, the upper bound of each band is inclusive, so 80% falls in the 60–80% band.
Rated banks (ECRA)
AAA to AA-: 20%; A+ to A-: 30%; BBB+ to BBB-: 50%; BB+ to B-: 100%; below B-: 150%
Unrated banks use SCRA: Grade A 40%, Grade B 75%, Grade C 150%. Grade A banks meeting stated minimum CET1 and leverage levels can get 30%.
Rated corporates
AAA to AA-: 20%; A+ to A-: 50%; BBB+ to BBB-: 75%; BB+ to BB-: 100%; below BB-: 150%; unrated: 100%
Some jurisdictions allow 65% for unrated investment-grade corporates and 85% for unrated SMEs.
Residential real estate, not materially dependent on property cash flows (whole loan)
LTV ≤ 50%: 20%; 50–60%: 25%; 60–80%: 30%; 80–90%: 40%; 90–100%: 50%; > 100%: 70%
Jurisdictions may allow loan-splitting instead: the portion up to 55% of property value gets 20%, the rest gets the counterparty's weight.
Residential real estate, materially dependent on property cash flows
LTV ≤ 50%: 30%; 50–60%: 35%; 60–80%: 45%; 80–90%: 60%; 90–100%: 75%; > 100%: 105%
Income-producing property costs more capital than owner-occupied property.
Commercial real estate
Not cash-flow dependent: LTV ≤ 60%: lower of 60% and counterparty weight; LTV > 60%: counterparty weight. Cash-flow dependent: LTV ≤ 60%: 70%; 60–80%: 90%; > 80%: 110%
Land acquisition, development and construction (ADC) is 150%, with a lower weight allowed for some pre-sold residential projects.
Retail
Regulatory retail: 75%; transactors: 45%; other retail: 100%
Regulatory retail must meet orientation, product, granularity and low-value criteria.

How to solve Revised Standardised Approach for Credit Risk questions

Use the same sequence for any question on this topic. Most marks are lost by picking the wrong exposure class or skipping a step.

  1. 1Identify the exposure class: sovereign, bank, corporate, specialised lending, retail, real estate, equity or defaulted.
  2. 2Check whether the exposure is on or off balance sheet. If off balance sheet, multiply the notional by the right CCF to get EAD.
  3. 3Choose the weight table. Banks: ECRA if rated, SCRA if unrated. Corporates: rating band, or unrated default. Real estate: residential or commercial, then whether repayment depends materially on property cash flows.
  4. 4For real estate, compute LTV = loan ÷ property value, then find the band. Remember upper bounds are inclusive.
  5. 5Apply any adjustment in the question, such as due diligence showing a higher risk, a past-due status, or a currency mismatch on retail or residential loans.
  6. 6Compute RWA = EAD × risk weight, then sum across exposures if asked.
  7. 7If asked for capital, multiply RWA by the required ratio, for example 8%, and state the interpretation.

Quickest way: Table-recall shortcut

When to use it: Use this when the question asks for a risk weight or a comparison and you have little time.

  1. Memorise the anchors: sovereign AAA to AA- 0%; bank AAA to AA- 20%; corporate BBB 75%; unrated corporate 100%; regulatory retail 75%.
  2. For residential real estate, remember the ladder 20, 25, 30, 40, 50, 70 as LTV rises.
  3. For off-balance-sheet items, scan for the commitment type first. If cancellable at any time without notice, use 10%.
  4. Eliminate options that use the old Basel II numbers, such as a flat 35% for mortgages or 0% CCF for cancellable commitments.
  5. Check the arithmetic: weight as a decimal × exposure. Confirm the answer sits between 0% and about 150% of the exposure.

Common mistakes in Revised Standardised Approach for Credit Risk

  • Using the old Basel II numbers, such as a flat 35% for residential mortgages or 100% for BBB corporates.

    Older textbooks and notes still show the pre-reform tables.

    Fix: Anchor on the revised tables: LTV-based mortgage weights and 75% for BBB corporates.

  • Placing an LTV of exactly 80% in the 80–90% band.

    Students read bands as lower-bound inclusive.

    Fix: Bands are upper-bound inclusive. 80% belongs to 60–80%, which is 30% for whole-loan residential not dependent on property cash flows.

  • Treating all real estate lending alike.

    Students skip the test of whether repayment depends materially on property cash flows.

    Fix: Check this first. Income-producing property has higher weights than owner-occupied residential property at the same LTV.

  • Applying a risk weight to the notional of a commitment without a CCF.

    Off-balance-sheet items look like loans, and the CCF step is forgotten.

    Fix: Always convert off-balance-sheet exposure to EAD with the CCF before applying the weight.

  • Assuming the external rating is always final.

    Students remember the rating table and forget due diligence.

    Fix: State that the bank must still assess the counterparty. If due diligence shows more risk than the rating suggests, a higher weight must be assigned.

  • Mixing up ECRA and SCRA for banks.

    Both apply to bank exposures and the labels sound similar.

    Fix: ECRA uses external ratings. SCRA is for unrated banks and grades them A, B and C at 40%, 75% and 150%.

Worked examples

Example 1

A bank grants a ₹-equivalent owner-occupied home loan of $425,000 against a property valued at $500,000. Repayment does not depend materially on the property's cash flows. Using the whole-loan approach under the Basel III revised standardised approach, what is the RWA?

A. $127,500
B. $170,000
C. $212,500
D. $425,000

Show the solution
  1. Classify the exposure: residential real estate, not materially dependent on property cash flows, whole-loan approach.
  2. Compute LTV = 425,000 ÷ 500,000 = 85%.
  3. Find the band: 80% < LTV ≤ 90%, so the risk weight is 40%.
  4. Compute RWA = 425,000 × 40% = $170,000.
  5. Check against the other options: $127,500 uses 30%, which is the 60–80% band; $212,500 uses 50%; $425,000 uses 100%.

Answer: B. $170,000

Example 2

A bank holds: a $10 million drawn loan to a BBB-rated corporate; a $4 million drawn loan to an unrated corporate (no special national treatment); $2 million of loans meeting the regulatory retail criteria; and a $5 million undrawn commitment, unconditionally cancellable at any time, to an unrated corporate. Using the revised standardised approach, what is total credit RWA?

A. $13.0 million
B. $13.5 million
C. $14.25 million
D. $15.0 million

Show the solution
  1. BBB corporate: weight 75%. RWA = 10 × 0.75 = $7.5 million.
  2. Unrated corporate: weight 100%. RWA = 4 × 1.00 = $4.0 million.
  3. Regulatory retail: weight 75%. RWA = 2 × 0.75 = $1.5 million.
  4. Undrawn commitment: unconditionally cancellable, so CCF = 10%. EAD = 5 × 0.10 = $0.5 million. Counterparty is an unrated corporate at 100%, so RWA = $0.5 million.
  5. Total = 7.5 + 4.0 + 1.5 + 0.5 = $13.5 million.
  6. Option A, $13.0 million, results from using the old 0% CCF.

Answer: B. $13.5 million

Exam tips

  • Questions are often scenario-based. First state the exposure class, then the weight. Doing so quickly avoids picking an old Basel II weight.
  • Expect LTV questions with numbers near band edges, such as exactly 60%, 80% or 90%. Remember that upper bounds are inclusive.
  • Look for the 'old versus revised' contrast: more granular weights, less mechanical reliance on ratings, higher CCF on cancellable commitments, and LTV-based real estate.
  • When a question mentions due diligence, the correct answer is usually that the bank must not rely solely on the external rating and must apply a higher weight if warranted.
  • Link to the output floor: a more risk-sensitive standardised approach makes the floor on internal-model RWA more meaningful.

Practice questions from Basel III: Finalising Post-crisis Reforms

Revised Standardised Approach for Credit Risk in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Revised Standardised Approach for Credit Risk: frequently asked questions

What is the main difference between the old and revised standardised approach?

The revised approach is more risk-sensitive and less dependent on external ratings. It adds LTV-based real estate weights, ECRA and SCRA for banks, a 75% weight for BBB corporates, and a 10% CCF for unconditionally cancellable commitments. It also strengthens due diligence expectations.

How do I calculate the risk weight for a mortgage under Basel III?

Compute LTV as the loan divided by the property value. Then check whether repayment depends materially on the property's cash flows. Pick the weight from the matching LTV band, and multiply it by the exposure to get RWA.

Can banks rely only on external ratings?

No. Banks must conduct due diligence to understand the risk of their counterparties. If the risk is higher than the rating or weight implies, the bank must assign a higher risk weight.

Why is the revised standardised approach important for FRM Part II?

It shapes regulatory capital for every bank, and through the output floor it limits the benefit from internal models. Exam questions test whether you can pick the right weight, apply the CCF and compute RWA correctly.