Economics • Banking & FinanceHard
What does the term 'Internal Ratings-Based (IRB) Approach' refer to under Basel capital adequacy frameworks?
A. A method allowing banks to use their internal risk models to compute risk-weighted assets for credit risk, subject to regulatory approval.✓ Correct Answer
B. An internal audit mechanism used to evaluate employee performance in loan underwriting.
C. A credit scoring model mandated by the central bank for retail lending institutions.
D. A standardized formula for assessing operational risk across foreign bank branches.
💡 Solution & Explanation
The Internal Ratings-Based approach under the Basel capital accords permits qualifying banks to utilize their internal econometric models to estimate credit risk components such as the probability of default, subject to rigorous supervisory review. Incorrect alternatives proposing internal audit mechanisms or standardized operational formulas misrepresent this specific credit risk metric. This framework allows more risk-sensitive capital requirements for sophisticated banking institutions.
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