Regulatory Capital Requirements for Line of Credit Products

Standards implemented by Basel III introduced capital requirements that impact different types of Line of Credit products. When pricing a Line of Credit, Capital needs to be held on both the outstanding balance (utilized) and the committed but unfunded (non-utilized) portions of the loan. In PrecisionLender, the only exception to this is the case where a Line of Credit product is marked as an Unconditionally Cancelable LOC, where capital is not held on the committed but unfunded portion of the loan. This type of LOC is discussed in detail later in this article.

 

Regulatory Capital

 

The required Capital is based on risk-weighted assets percentage (RWA), and in most cases, the RWA is 100% (Loan Products with Special Regulatory Capital Requirements goes into further details about products with non-100% RWA).

One factor in determining capital is simply to take the committed and funded value * RWA.

Capital held on the unfunded portion of the loan introduces a Credit Conversion Factor (CCF), which is based on the duration of the loan. Under the regulatory guidance based on Basel III, the CCF is 20% if the loan is 12 months or less. If the duration is greater than 12 months, the CCF is 50%. Thus the unfunded risk weighting is the Unfunded amount * RWA * CCF.

The sum of the funded and unfunded risk weighted assets is then multiplied by the Regulatory Capital factor. Under US regulatory requirements, a bank’s tier 1 and tier 2 capital must be at least 8% of its risk-weighted assets for an adequately capitalized institution.

 

Formula

(Commitment Funded * RWA + Commitment Unfunded * RWA * CCF) * Regulatory Capital %

 

Examples

$1,000,000 LOC, 12 months, 60% utilization

($600,000 * 100% + $400,000 * 100% * 20%) * 8% = $54,400

 

$1,000,000 LOC, 36 months, 60% utilization

($600,000 * 100% + $400,000 * 100% * 50%) * 8% = $64,000

 

Unconditionally Cancelable (Demand) Line of Credit

 

This type of LOC can be enabled by checking the "Is Cancelable LOC" box on the Product page (where payment type is LOC) in the Administration section. When enabled, Line of Credit opportunities priced do not hold Capital on the committed but unfunded portion of the loan in the Regulatory calculation.

In other words, a Unconditionally Cancelable LOC will ignore the second half of the formula above (Unfunded amount * RWA * CCF).

 

Formula

Commitment Funded * RWA * Regulatory Capital %

 

Examples

$1,000,000 LOC, 12 months, 60% utilization

$600,000 * 100% * 8% = $48,000

 

$1,000,000 LOC, 36 months, 60% utilization

$600,000 * 100% * 8% = $48,000