The Advanced Internal Rating-Based (AIRB) Approach is a framework for banks to use when estimating the probability of default (PD) of a borrower. The AIRB Approach was developed by the Basel Committee on Banking Supervision (BCBS) and first published in 2003.
Under the AIRB Approach, a bank must first develop an internal rating system for borrowers. This internal rating system must take into account a number of factors, including the borrower's credit history, financial statement analysis, and other relevant information. Once the internal rating system is in place, the bank must then estimate the PD of each borrower.
The AIRB Approach is an alternative to the Standardized Approach, which is the other approach that banks can use to estimate PD. The main advantage of the AIRB Approach is that it allows banks to use their own internal data and models to estimate PD, which can lead to more accurate estimates. The main disadvantage of the AIRB Approach is that it is more complex than the Standardized Approach and thus requires more resources to implement.
How is LGD calculated?
LGD, or loss given default, is a measure of the expected loss on a loan if the borrower defaults. It is typically expressed as a percentage of the loan amount.
There are a number of ways to calculate LGD, but the most common method is to use historical data on past defaults. This approach looks at the losses that were incurred on loans where the borrower defaulted, and then estimates the expected loss on a new loan based on those historical losses.
Other methods for calculating LGD include using market data on the prices of defaulted loans, or using a model to simulate the likely losses from a default.
What is internal and external credit rating? The Internal Credit Rating (ICR) is a credit assessment made by a bank's own credit department of the borrower's ability to repay a loan. External Credit Rating (ECR) is a credit assessment made by an external credit rating agency, such as Standard & Poor's, Moody's, Fitch, etc.
The ICR is generally more comprehensive, because the credit department has access to more information about the borrower. However, the ECR may be more objective, because the credit rating agency is not biased in favor of the borrower.
What is IRB approval?
IRB stands for "Investment Review Board." The IRB is a group of individuals within a bank who are responsible for reviewing and approving investment proposals. Investment proposals can be for a variety of things, including new products, new services, or new ways of doing business.
The IRB must approve all investment proposals before they can proceed. This ensures that all investments are made with the best interests of the bank in mind and that they are in line with the bank's overall strategy.
IRB approval is a critical part of the investment process, and it is important for banks to have a strong and effective IRB in place. What is Basel IV in simple terms? Basel IV is a set of banking regulations formulated by the Basel Committee on Banking Supervision. The primary purpose of these regulations is to ensure that banks have sufficient capital to absorb losses during periods of financial stress, and to promote a more risk-sensitive approach to banking.
Basel IV builds on the previous Basel III framework, and introduces several new concepts and requirements. For example, Basel IV requires banks to use a more sophisticated approach to calculating their capital requirements, known as the "standardized approach". This approach takes into account a number of factors, including the credit risk of the assets on a bank's balance sheet, the volatility of those assets, and the correlation between different types of risk.
In addition, Basel IV introduces the concept of "risk-weighted assets", which are assets that are weighted according to their riskiness. This means that banks will have to hold more capital against riskier assets, such as loans to companies with a high debt-to-equity ratio.
Finally, Basel IV includes a number of provisions aimed at addressing specific risks that have become more prominent in recent years, such as cyber risk and the risk of "run-offs" (when customers withdraw their deposits en masse).
In summary, Basel IV is a response to the global financial crisis of 2008, and is designed to make the banking system more resilient to future shocks. It does this by requiring banks to hold more capital, and by introducing new rules and regulations that are intended to make banks more aware of the risks they are taking on.
How is RWA calculated? The Basel Committee on Banking Supervision defines the minimum requirements for banking regulators to use when they are calculating the risk-weighted assets (RWA) of banks. The requirements are laid out in the Basel III agreement.
In order to calculate the RWA of a bank, regulators must first determine the risk of each of the assets on the bank's balance sheet. The Basel III agreement provides guidance on how to do this, but ultimately it is up to the regulator to determine the risk of each asset.
Once the risk of each asset has been determined, the regulator must then calculate the RWA of the bank. This is done by multiplying the risk of each asset by its weight in the overall asset portfolio. The weights are set by the Basel III agreement and are meant to reflect the riskiness of each type of asset.
The RWA of a bank is a key metric that is used to determine the amount of capital the bank must hold. The higher the RWA, the more capital the bank must hold. This is because assets with a higher RWA are considered to be more risky and therefore require more capital to offset the risk.