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CS Professional · Banking and Insurance - Laws and Practice · Risk Management in Banks and Basel Accords

Under Basel II, a bank wishes to use its own internal ratings to estimate the probability of default of borrowers for computing credit-risk capital. Which approach permits this, subject to supervisory approval?

The internal ratings-based approach allows a bank to use its own estimates of borrower default probability for credit-risk capital, subject to supervisory approval. The standardised approach relies on external ratings, and the basic indicator approach applies to operational risk.

  1. AStandardised approach using external ratings only
  2. BBasic indicator approach
  3. CInternal ratings-based approachCorrect
  4. DSimple risk-weight approach of Basel I

Explanation

Basel II offers the standardised approach (external ratings) and the internal ratings-based (IRB) approach, where banks use internal estimates such as probability of default, with supervisory approval. The basic indicator approach relates to operational risk, not credit risk.

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