for loan commitments, since a distressed borrower is likely to use a substantial part of
initially undrawn loan commitments before defaulting, unless the bank has the chance to
revoke the commitment and is able to anticipate the problem. The problem is more relevant
for high-quality borrowers, since they can obtain larger commitments and the difference
between the drawn portion in normal conditions and at default may be larger (see Table
As a consequence, Basel II forces banks adopting either the standardized or the FIRB
approach to translate off-balance sheet items, such as loan commitments, into credit-
exposure equivalents by multiplying them by a credit-conversion factor (see Basel Com-
mittee 2006a, §§82–87 and §§311–315). Only facilities that are unconditionally cancellable
by the bank or are automatically cancelled in case of a deterioration in borrower’s credit-
worthiness are given a 0% credit-conversion factor. In the AIRB, banks may estimate
EAD internally but, again, adopting a conservative approach, especially for exposures
where EAD were expected to increase during downturns (Basel Committee 2006a, §475).
In fact, both PD and EAD are likely to grow in bad years, and this could make unexpected
losses higher than if they were independent. Therefore, even banks that will not apply for
the AIRB approach should try to study the potential correlation between the use of the
undrawn portion of loan commitments, default rates, and the economic cycle, since this
information should enter into the pricing policies for commitments and provide further
incentives to continuous credit monitoring. In fact, even in those cases where a credit line
can be discretionally revoked and hence would not imply any extra exposure and a speci c
capital requirement, the undrawn portion of the credit line represents a risk for the bank,
unless the bank’s credit-monitoring system (based on either a behavioral score or periodic
credit review by analysts) proves to be able to anticipate the deterioration of the borrower’s
nancial health.
4.8 Interaction between Basel II and International
Accounting Standards
So far we have discussed credit risk management issues from the viewpoint of risk man-
agers and supervisors. But a third perspective has to be considered: accountants’ view
about credit risk. This topic is particularly relevant now for European banks due to the
introduction of new IAS/IFRS accounting principles and the consequent potential con-
cerns for their consistency with supervisors’ and risk managers’ objectives. We should
TA B L E 4 - 9 Drawn and Undrawn Portions of Loan Commitments as a Function of Initial
Rating Class Drawn Portion of Loan Commitment Average of the Normally Undrawn Portion
That Is Drawn in Case of Default
AAA 0.1% 69%
AA 1.6% 73%
A 4.6% 71%
BBB 20.0% 65%
BB 46.8% 52%
B 63.7% 48%
CCC 75.0% 44%
Source: Asarnow and Marker (1995).

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