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FRM Part II · FRM Exam Part II · Credit Risk Management

Under the Basel internal ratings-based (IRB) framework, which statement about the capital charge for a corporate exposure is correct?

The IRB risk-weight function targets a one-year horizon at a 99.9% confidence level, derived from a single-factor model, and the capital requirement covers unexpected loss only. Expected loss is addressed separately through provisions, so the other statements about confidence level, PD and correlation are wrong.

  1. AIt depends only on the bank's own estimate of loss given default, with probability of default set by the supervisor in all IRB approaches
  2. BThe risk-weight function is calibrated to a one-year, 99.9% confidence level and capital covers unexpected loss, with expected loss handled through provisionsCorrect
  3. CIt is calibrated to a 95% confidence level and covers both expected and unexpected losses
  4. DIt is independent of asset correlation because correlation is captured in the maturity adjustment

Explanation

The IRB formula is derived from the Vasicek single-factor model at 99.9% over one year. Capital addresses unexpected loss; expected loss is covered by provisions. Option A describes foundation IRB incorrectly, since banks estimate PD in both approaches. Options C and D misstate the confidence level and the role of correlation.

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