Part II Commercial Banking, 10 The Internal Ratings-Based Approach
- Banks as a lender — Regulation of banks — Credit risk — Default and credit — Financial regulation — Basel accords
This chapter discusses the internal ratings-based approach (IRB). The IRB permits a bank to use its internal models to derive risk weights for particular exposures. There are two available bases for the IRB: foundation (F-IRB), which permits the bank to model Probability of Default (PD), but relies on regulatory standard figures to determine Loss Given Default (LGD) and Exposure at Default (EAD); and advanced (A-IRB), in which all three of these are modelled. The A-IRB IRB approach models PD, LGD, EAD, and M. Both IRB approaches model both expected loss (EL) and unexpected loss (UL), and IRB banks are expected to recognise the EL derived from their models in their capital calculations. Consequently, a bank using an IRB approach will generally have a different total capital level from that which it would have if it were an SA bank.