FRM Exam Part II · Basel III: Finalising Post-crisis Reforms

Revised IRB Approach and Input Floors Explained

Updated 11 October 2026 · Fact-checked

The revised IRB approach in Basel III finalisation limits where banks can use their own models. Advanced IRB is barred for large corporates and financial institutions, and IRB is barred for equities. Banks must also apply floors to PD, LGD and EAD inputs. To solve questions, identify the exposure class, the permitted approach, then the binding floor.

Understand Revised Internal Ratings-Based Approach and Input Floors

Under the IRB approach, a bank uses internal estimates of PD (probability of default), LGD (loss given default) and EAD (exposure at default) to compute risk-weighted assets. Before the crisis, banks had wide freedom. Regulators found that model choices produced very different risk weights for similar portfolios. Basel III finalisation (2017) narrows that freedom.

There are two IRB variants. In foundation IRB (F-IRB), the bank estimates PD only. The supervisor sets LGD and the credit conversion factors that drive EAD. In advanced IRB (A-IRB), the bank estimates PD, LGD and EAD itself.

The reforms work in two ways. First, they remove modelling options where models are hard to calibrate. A-IRB is no longer allowed for exposures to large and mid-sized corporates (consolidated revenue above €500 million) and to financial institutions. These move to F-IRB or the standardised approach. IRB is not allowed at all for equity exposures. Specialised lending where PD cannot be estimated reliably uses supervisory slotting.

Second, they add input floors. Even if a bank's model gives a very low PD, LGD or EAD, the floor value is used in the capital formula. Floors stop capital from falling too far on low-default portfolios. The framework also removes the 1.06 scaling factor on IRB credit RWA and raises asset value correlation by a 1.25 multiplier for large regulated financial institutions and unregulated financial institutions. The output floor then works as a further backstop on total RWA.

Key formulas to remember

A-IRB restriction: Corporate revenue > €500 million, or financial institution → F-IRB only (no A-IRB); Equities: IRB not permitted; use standardised approach. Retail and corporates with revenue ≤ €500 million can still use A-IRB if approved.
PD floors: Corporate and bank: 0.05%. Retail mortgages: 0.05%. QRRE transactors: 0.05%. QRRE revolvers: 0.10%. Other retail: 0.05%; The corporate floor was previously 0.03%. Floor applies to the PD used in the formula.
LGD floors (unsecured): Corporate: 25%. Retail mortgages: 5%. QRRE: 50%. Other retail: 30%; A-IRB banks apply these to own LGD estimates. Secured exposures have lower floors by collateral type.
LGD floors (secured, by collateral): Financial collateral: 0%. Receivables: 10%. Commercial or residential real estate: 10%. Other physical collateral: 15%; Corporate and other retail secured exposures. Mortgages keep the 5% floor.
EAD floor: EAD ≥ drawn amount + 50% × (off-balance-sheet amount × standardised CCF); Applies to A-IRB own EAD estimates. F-IRB CCFs are aligned with the standardised approach.
Supervisory LGD (F-IRB): Senior unsecured corporate: 40%. Senior unsecured financial institution: 45%. Subordinated: 75%; Corporate figure was cut from 45% to 40%. Collateral reduces LGD.
Expected loss with floors: EL = max(PD, PD floor) × max(LGD, LGD floor) × max(EAD, EAD floor); Use for exam arithmetic. The floors bind only when the model value is lower.

How to solve Revised Internal Ratings-Based Approach and Input Floors questions

Most questions test two things: which approach is allowed, and which floor applies. Work in a fixed order so you do not mix them up.

1Identify the exposure class: large or mid-sized corporate, SME corporate, financial institution, equity, specialised lending or retail.
2Check the revenue test for corporates. Consolidated revenue above €500 million means no A-IRB.
3Decide the allowed approach: equity goes to standardised, financial institutions and large corporates go to F-IRB (or standardised), others may use A-IRB if approved.
4List which inputs the bank estimates itself. F-IRB: PD only. A-IRB: PD, LGD and EAD.
5Compare each model input with its floor. Use the higher of model value and floor.
6For EAD, compute drawn plus 50% of off-balance-sheet amount at the standardised CCF, and compare.
7Recompute the requested measure (EL, RWA direction or capital impact) with floored inputs.
8Interpret: floors raise capital for low-risk, well-secured portfolios and reduce model variability.

Quickest way: Three-question filter

When to use it: Use for conceptual MCQs asking which approach or floor applies.

Ask: who is the borrower? Equity means standardised. Bank or large corporate means no A-IRB.
Ask: who estimates what? F-IRB means bank PD only.
Ask: is the model number below the floor? If yes, replace it with the floor and recompute. Remember 0.05% PD, 25% unsecured corporate LGD, 50% off-balance-sheet EAD add-on.

Common mistakes in Revised Internal Ratings-Based Approach and Input Floors

Saying A-IRB is banned for all corporates.
Students remember 'corporates' and forget the revenue condition.
Fix: Only corporates with consolidated revenue above €500 million are barred from A-IRB. Smaller corporates can still use it.
Saying IRB is barred for retail or specialised lending.
Mixing up the restricted classes.
Fix: Retail stays eligible for A-IRB. Specialised lending uses slotting where PD cannot be estimated. Equities are the class with no IRB at all.
Applying the PD floor of 0.05% to every retail product.
Memorising one number for all.
Fix: QRRE revolvers have a 0.10% PD floor. Others are 0.05%.
Using the floor even when the model value is higher.
Treating a floor as a fixed input.
Fix: A floor is a minimum. Use the higher of model estimate and floor.
Applying the EAD floor as 50% of total exposure.
Forgetting that only the off-balance-sheet part gets 50%.
Fix: The floor is the full drawn amount plus 50% of off-balance-sheet EAD computed with the standardised CCF.
Confusing the input floors with the output floor.
Both are called floors and both raise capital.
Fix: Input floors apply to PD, LGD and EAD per exposure. The output floor limits total RWA from models relative to the standardised approach.

Worked examples

Example 1

Under the Basel III finalised framework, which exposure can still be treated under the advanced IRB approach, subject to supervisory approval? (A) Exposure to a bank counterparty (B) Corporate borrower with consolidated revenue of €800 million (C) Equity holding in a listed company (D) Portfolio of residential mortgage loans to individuals

Show the solution

Option A: financial institution exposures are restricted to F-IRB or standardised, so A-IRB is not allowed.
Option B: revenue above €500 million makes it a large corporate, so A-IRB is not allowed.
Option C: equity exposures cannot use IRB at all.
Option D: retail mortgages remain eligible for A-IRB with own PD, LGD and EAD, subject to floors (PD 0.05%, LGD 5%).

Answer: (D) Portfolio of residential mortgage loans to individuals.

Example 2

A bank uses A-IRB for an unsecured loan to a corporate with consolidated revenue of €300 million. Drawn amount is $40 million and undrawn commitment is $20 million. Assume the standardised CCF is 40%. Model estimates: PD 0.03%, LGD 20%, EAD $42 million. Compute regulatory expected loss with floors.

Show the solution

Eligibility: revenue €300 million is below €500 million, so A-IRB is allowed.
PD: floor is 0.05%. Model 0.03% is lower, so use 0.05%.
LGD: unsecured corporate floor is 25%. Model 20% is lower, so use 25%.
EAD floor: off-balance-sheet EAD = 20 × 40% = $8 million. Floor = 40 + 50% × 8 = $44 million. Model $42 million is lower, so use $44 million.
EL = 0.0005 × 0.25 × 44,000,000 = $5,500.

Answer: Expected loss using floored inputs is $5,500, with PD 0.05%, LGD 25% and EAD $44 million.

Exam tips

Memorise the three restrictions as a list: large corporates (revenue above €500 million), financial institutions, equities. Know which gets F-IRB and which gets standardised.
Know the headline floor numbers: PD 0.05%, unsecured corporate LGD 25%, EAD add-on 50% of off-balance-sheet at the standardised CCF.
In calculation questions, test every input against its floor before multiplying. Questions often make only one input binding.
Expect interpretation items: floors and A-IRB limits reduce RWA variability and make IRB less able to lower capital on low-default portfolios.
Do not confuse input floors with the output floor. Read the question wording to see which one is asked.

Practice questions from Basel III: Finalising Post-crisis Reforms

Revised Internal Ratings-Based Approach and Input Floors: frequently asked questions

What is the difference between foundation IRB and advanced IRB under Basel III?

In foundation IRB, the bank estimates PD and the supervisor sets LGD and the CCFs for EAD. In advanced IRB, the bank estimates PD, LGD and EAD itself. Basel III finalisation bars A-IRB for some exposure classes and adds floors to the A-IRB inputs.

Which exposures cannot use advanced IRB under Basel III?

Exposures to large and mid-sized corporates with consolidated revenue above €500 million, and exposures to financial institutions, cannot use A-IRB. Equity exposures cannot use IRB at all. Specialised lending where PD cannot be estimated uses supervisory slotting.

What are the PD, LGD and EAD floors?

The PD floor is 0.05% for corporates and most retail, with 0.10% for QRRE revolvers. LGD floors include 25% for unsecured corporate and 5% for retail mortgages. The EAD floor is the drawn amount plus 50% of the off-balance-sheet amount at the standardised CCF.

Do the floors always increase capital?

No. A floor only binds when the bank's own estimate is below it. If the model value is already higher, the model value is used.