The Capital Requirements Regulation (CRR) contains two alternative approaches to define the equity requirements for credit risks:
- the Credit Risk Standardized Approach (CRSA)
- the IRB Approach (IRBA) based on internal assessments
Credit Risk Standardized Approach (CRSA) to Calculate the Equity Requirements
In the standardized approach, the risk weighting of the credit risk positions can be calculated on the basis of external credit ratings. Risk weightings of 0 to 1.250% are assigned to credit risk positions on the basis of receivables class and the external credit ratings. The general risk weightings are set for unassessed positions. In addition, the standardized approach (CRSA) also has receivable classes in which external credit ratings generally do not play any role for the risk weighting. Solely general risk weightings are used for them, only taking account of the type of credit risk position.
IRB Approach (IRBA) to Calculate the Equity Requirements
The IRB approach based on internal analyses and ratings give financial institutions another approach besides the CRSA to weight credit risk positions. As part of the IRB approach, a difference is usually made between whether and to what extent an institution itself estimates only the probability of default (PD) outside of the so-called retail business (classic credit or lending business) (basic approach) or whether the loss given default (LGD) is also taken into account (advanced approach).
Quantification of Equity Requirement
As part of both approaches, internal systems in institutions must be implemented to quantify the corresponding equity requirement. Each borrower is assigned to a certain rating level on the basis of the credit ratings. The risk weighting to be applied for each credit risk position primarily takes account of the likelihood that the borrower will not meet their payment obligations in full. The internally calculated probabilities of default per rating level are frequently estimated on the basis of historical data.
Procedural Challenges in the Calculation of the Credit Risk
In addition to the professional and technical hurdles, institutions frequently face procedural challenges when calculating the credit risk, beginning with the collection of the necessary information on the credit worthiness of the debtor, and extending to the processing of this information and the ensuring of consistency in the used data, particularly with regard to the amended impairment requirements within the meaning of IFRS 9.
FAS Support for Calculating the Credit Risk
FAS AG will support you and your company in the conception and implementation of a suitable credit risk calculation system, with consideration given to the institution’s internal requirements, regulatory requirements and processes within the company.
If you are interested or have any questions, please contact us.