Credit Risk RWAs

Question 1

What is credit risk?

Answer 1

Credit risk is the risk a borrower or issuer will fail to meet their obligations

Question 2

What are the two approaches for calculating credit risk?

Answer 2

1) Standardized approach (STD)

2) Internal Ratings Based approach (IRB)

Question 3

Under the standardized approach, how are credit risk weights calcualted?

Answer 3

External fixed weights are applied dependent on:

1) Counterparty type

2) External Credit Assessment Institution (ECAI)

Question 4

Under the IRB approach, how are credit risk weights calcualted?

Answer 4

You take the following inputs:

1) Probability of default
2) Loss given default
3) Maturity

And put them into one of these two models:

1) Foundation IRB (FIRB)
2) Advance IRB (AIRB)

Question 5

What is the difference between the foundation IRB and advanced model?

Answer 5

In the foundation, only the probability of default is internally provided. All other inputs (Loss given default and maturity) are provided by the regulator

In the advanced model, all inputs are provided internally and need to be approved by the regulator