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FRM Part II · FRM Exam Part II · High-level Summary of Basel III Reforms

Which of the following is a change introduced by Basel III post-crisis reforms to the internal ratings-based (IRB) approach for credit risk?

The reforms remove advanced IRB for exposures to financial institutions and large corporates, leaving foundation IRB, where supervisors set LGD and EAD, or the standardised approach. This reduces model risk and variability for portfolios with limited default data. Own LGD and EAD estimates are no longer allowed there.

  1. AAdvanced IRB is mandated for all exposures to large corporates and financial institutions
  2. BBanks may use their own LGD and EAD estimates for exposures to financial institutions and large corporates
  3. CRemoval of the use of the risk-weight function for retail exposures
  4. DRemoval of the use of advanced IRB for exposures to financial institutions and large corporates, with foundation IRB onlyCorrect

Explanation

The reforms removed the option to use internal models (advanced IRB) for exposures to large corporates (consolidated revenues above EUR 500m) and financial institutions, as well as equity exposures, leaving foundation IRB or standardised. Own LGD and EAD estimates for those exposures are therefore no longer permitted.

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