Under Basel II, banks are allowed to use their own estimated risk parameters for the purpose of calculating regulatory capital. This is known as the Internal Ratings Based Approach (IRB) of the capital requirements for credit risk. Only banks meeting certain minimum requirements and approved by the national supervisor are allowed to use this approach to estimate capital for various exposures.
To use this approach, a bank must take two major steps:
- Categorize their exposures into different asset classes as defined by the Basel II Accord
- Estimate risk parameters (probability of default (PD), loss on default (LGD), default exposure (EAD), maturity (M) ) are risk weighting function inputs designed for each class Assets to arrive at Total Risk Weighted Assets (RWA).
Regulatory capital for credit risk is then calculated at 8% of total Basel II risk-weighted assets. RISK DATA Consulting assists your risk management department in the estimation of PD, LGD, EAD and calculation of RWA and Provision IFRS9