Some formulae in internal-ratings-based approach
Some credit assessments in standardised approach refer to unrated assessment. Basel II also encourages banks to initiate internal ratings-based approach for measuring credit risks. Banks are expected to be more capable of adopting more sophisticated techniques in credit risk management. Banks can determine their own estimation for some components of risk measure: the probability of default (PD), exposure at default (EAD) and effective maturity (M). The goal is to define risk weights by determining the cut-off points between and within areas of the expected loss (EL) and the unexpected loss (UL), where the regulatory capital should be held, in the probability of default. Then, the risk weights for individual exposures are calculated based on the function provided by Basel II. Below are the formulae for some banks’ major products: corporate, small-medium enterprise (SME), residential mortgage and qualifying revolving retail exposure. Notes: * 10 Function is taken from paragraph 272 * 11 Function is taken from paragraph 273 * 12 Function is taken from paragraph 328 * 13 Function is taken from paragraph 229 IThe advantages
* Basel-II benefits customers with lower probability of default. * Basel-II benefits banks to hold lower capital requirement as having corporate customers with lower probability of default (Graph 1). * Basel-II benefits SME customers to be treated differently from corporates. * Basel-II benefits banks to hold lower capital requirement as having credit card product customers with lower probability of default (Graph 2). image:Cardrisk.jpgReferences
