The internal ratings-based (IRB) approach

Just as car dealers allow you to buy differently priced cars, the BCBS makes an additional distinction between the foundation and the advanced IRB approaches. Since the key insights can be discussed with the foundation IRB approach, we shall focus on this one. Later, we shall indicate the benefits of using the advanced approach.

In the IRB approach, banks have to calculate the probability (likelihood) of default of a corporate client over a one-year horizon. That is, lending today to a client, what is the probability of default of the borrower in one year’s time? This probability of default is referred to as the PD. In the case of retail loans, a similar probability of default can be calculated for a ...

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