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FRM Part II · FRM Exam Part II · Credit Risk

In the Basel IRB formula, the capital requirement K is intended to cover which portion of credit losses at a 99.9% confidence level over one year?

The IRB capital requirement covers unexpected loss only. It is the loss at the 99.9% confidence level less expected loss, because expected loss is expected to be absorbed by pricing and provisions. Losses beyond the 99.9th percentile are not covered by the charge.

  1. AUnexpected loss only, as expected loss is covered by provisions and pricingCorrect
  2. BExpected loss plus unexpected loss
  3. CExpected loss only
  4. DLosses beyond the 99.9th percentile

Explanation

The IRB capital charge is the 99.9% conditional loss minus expected loss (PD x LGD), so it addresses unexpected loss. Expected loss is handled through provisions. Losses beyond 99.9% are by design not covered.

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