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CMA Final · Risk Management in Banking and Insurance · Credit Risk Management

Which feature distinguishes the Internal Ratings-Based (IRB) approach from the standardised approach to credit risk under Basel norms?

The IRB approach lets a bank use its own internal estimates of risk parameters such as probability of default, with supervisory approval, to derive capital requirements. The standardised approach instead uses regulator-prescribed risk weights tied to external ratings or exposure categories.

  1. ARisk weights are fixed by the regulator purely on external rating grades
  2. BBanks use their own internal estimates of risk parameters such as PD, subject to supervisory approvalCorrect
  3. CIt applies only to market risk positions
  4. DIt removes the need to hold any capital against retail loans

Explanation

Under IRB, with supervisory approval, banks estimate parameters like PD (and, in the advanced approach, LGD and EAD) using internal models. The standardised approach relies on regulator-prescribed risk weights linked to external ratings.

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