The term Advanced IRB
is an abbreviation of advanced internal rating-based approach
and it refers to a set of credit risk measurement techniques proposed under Basel II capital adequacy
rules for banking institutions.
Under this approach the banks are allowed to develop their own empirical model to quantify required capital for credit risk. Banks can use this approach only subject to approval from their local regulators. For more background on the types of models banks have applied, see the Jarrow-Turnbull model
Under A-IRB banks are supposed to use their own quantitative models to estimate PD
and other parameters required for calculating the RWA
. Then total required capital
is calculated as a fixed percentage of the estimated RWA.
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), loss given default (LGD), exposure at default (EAD) and effective maturity (M). For public companies, default probabilities are commonly estimated using either the structural model of credit risk proposed by Robert Merton (1974) or reduced form models like the Jarrow-Turnbull model
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