Basel II capital requirements for Credit Risk
Maturity = 1 year
Default correlation for corporate, sovereign and bank exposures:
Worst-case default rate:
Capital requirements:
Risk-weighted assets:
\( RWA = 1/0.08 \times (Cap. \; req.) = 12.5 \times (Cap. \; req.) \)Foundation IRB
Under the Foundations Approach, a bank estimates the one-year probability of default (PD) associated with each of its internal rating grades, while relying on supervisory rules for the estimation of other risk components.
The PD estimate must represent a conservative view of a long-run average PD, ‘through the economic cycle’, rather than a short-term assessment of risk.
The BIS assumes LGD to be 50% for unsecured loans, 45% for loans secured by physical non-real-estate collateral, and 40% if secured by receivables.
Advanced IRB
Under the advanced IRB approach, banks supply their own estimates of the PD, LGD, EAD for corporate, sovereign, and bank exposures.
Both foundation and advanced IRB use the same formula to calculate risk-weighted assets. The difference is who estimate the inputs for the formula.
Risk Weights in the standard approach
Under this approach the banks are required to use ratings from External Credit Rating Agencies to quantify required capital for credit risk.
In many countries this is the only approach the regulators are planning to approve in the initial phase of Basel II Implementation.
The standardized approach, which is conceptually the same as under Basel I, but more risk-sensitive. Risk-weights in percent of principal:
