The disparity in PD and LGD estimates within the IRB framework and prospects for future improvement

Patricia Stupariu (), Juan Rafael Ruiz () and Ángel Vilariño ()
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Patricia Stupariu: Universidad Complutense deMadrid
Juan Rafael Ruiz: Universidad Complutense deMadrid
Ángel Vilariño: Universidad Complutense deMadrid

Journal of Banking Regulation, 2019, vol. 20, issue 4, No 5, 347 pages

Abstract: Abstract The internal ratings-based approach (IRB) to calculating capital requirements for credit risk was the main novelty brought about by Basel II and remains fundamentally unchanged in Basel III. The adequacy of this framework has been controversial since its inception, but throughout the years, most regulators and the banking industry have remained among its strong supporters. This paper focuses on some of the most problematic elements of the IRB approach, concerning the estimation of the main parameters capital requirements depend on and the difficulty embedded in the validation process. In the light of these difficulties, it concludes maintaining the IRB approach in its current form and scope reflects an overly optimistic stance with respect to financial institutions’ ability to accurately estimate critical risk parameters and prospects for future improvements.

Keywords: Basel; IRB; LGD; Credit Risk; Financial Regulation (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1057/s41261-019-00099-9

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