The term Foundation IRB
is an abbreviation of foundation internal ratings-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 estimate the PD
for individual clients or groups of clients. Banks can use this approach only subject to approval from their local regulators.
Under F-IRB banks are required to use regulator's prescribed LGD
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), 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... Read More