Capital Adequacy Treatment of Debt Issues Covered by the Crown Wholesale Guarantee Scheme

The Government announced the Crown wholesale funding guarantee scheme on 1st November 2008. The purpose of this letter is to clarify how New Zealand-incorporated registered banks should treat any debt they acquire which is covered by a guarantee under the scheme, in the calculation of their required capital for credit risk under the Reserve Bank’s capital adequacy regime.

Under the Basel II Standardised approach for credit risk, guaranteed exposures receive the risk weight of the guarantor rather than the borrower provided that the guarantee satisfies a number of conditions. In the Reserve Bank’s implementation of Basel II, these conditions are set out in paragraphs 73-80 of the Banking Supervision Handbook document BS2A, Capital Adequacy Framework (Standardised Approach). We have assessed the final specimen deeds for both the Crown Wholesale Funding Guarantee Facility and the Crown Wholesale Funding Guarantee, as published by the Treasury on 15th December, and we have seen nothing to suggest that the guarantee they would put in place does not meet the conditions in BS2A.

On this basis, a bank on the Standardised approach may assign the risk weight applicable to the New Zealand government to any debt instrument it holds that is covered by the wholesale funding guarantee scheme. In accordance with paragraph 28 of BS2A, claims on the New Zealand government denominated in NZ$ carry a 0% risk weight. Claims on the New Zealand government denominated in any other currency also carry a 0% risk weight as long as New Zealand’s long-term foreign currency credit rating is at or above AA- /Aa3, as at present. Thus at present, based on the specimen deeds and our assessment of them, guaranteed debt issues would carry a 0% risk weight.

Banks that have been accredited to use the Advanced Internal Ratings-Based (AIRB) approach for calculating their credit risk capital requirements may adjust the PD (probability of default) or LGD (loss given default) on debt issues they own, to reflect the presence of a guarantee. This will be in accordance with their own internal approaches, subject to the requirements set out in paragraphs 4.98 to 4.104 and 4.129 to 4.132 of document BS2B, Capital Adequacy Framework (Internal Models Based Approach). (See the Banking Supervision Handbook at: http://www.rbnz.govt.nz/finstab/banking/regulation/0094291.html )

Please note that the specimen deeds of guarantee leave scope for additional special conditions that may be added to the guarantee of any actual issue of debt securities. These or other variations in the deeds that are actually put in place could affect the eligibility of a guarantee to allow a reduced risk weight. It is the responsibility of any potential investor in a specific debt issue covered by a guarantee under the scheme to carry out their own due diligence to form their own view on the issue’s credit risk. Registered banks in addition should satisfy themselves of the correct capital adequacy treatment of the issue.

If you have any questions about this letter please contact the Reserve Bank analyst for your bank in the first instance.