Basel III and IRB approach

The Basel Pact emphasizes capital requirements as a safeguard for the financial institution to absorb future risky losses when all reserves have been depleted. Initially, a capital adequacy ratio (RAR asset risk ratio) of 8% was set, which is an international measure of creditworthiness but also the minimum acceptable level of capital risk coverage of banks. New improvements to include operational risk have prompted new methods to be included in the denominator of the capital adequacy ratio, with the minimum constant remaining constant at 8%. The assessment of credit risk at the denominator of the capital adequacy ratio can be done in two ways.

In the standard approach, where the weighted credit risk weights are based on the ratings of external credit rating agencies. With the risks undertaken by a bank to be determined according to the rating of the counterparty based on external evaluation procedures. (That is, low creditworthiness counterparties are weighted with a high risk factor).

The internal grading approach, which includes two versions depending on the level of internal grading systems. First, the fundamental method of internal rating systems where the calculation of the estimated probability of default is required. Secondly the advanced method of internal rating systems which must calculate the losses and the exposure of the counterparty in case of default. Using the basic method, the estimation of the probability of default is made by the banking institution itself, while the other estimates of the risk factors are determined by the supervisory authorities.

The internal risk-based credit risk approach is a complex framework that allows banks to model their own inflows to calculate weighted assets more accurately, resulting in a more accurate calculation of capital requirements. Extensive flexibility in the development of internal models has therefore been formulated to allow for a high degree of risk sensitivity, ie more appropriately tailored to bank portfolios. To be eligible for an internal approach assessment, banks will have to meet certain minimum requirements, requirements and approval by the national supervisory authority. The basic premise of the Internal Assessment (IRB) approach is that differences in risk weight from different reports should ideally reflect differences in the underlying risk of these reports, including portfolio structure, customer characteristics and transactions, and internal risk management procedures. Given this hypothesis, the outcome model of the IRB Approach should ideally lead to similar capital requirements in banks with similar portfolios, with the exception of some justified by differences in risk profiles.

Basel III sets two new banks' liquidity ratios to cover a bank's liquidity needs in extreme scenarios aimed at eliminating investment and financing mismatches in the short term with the regulation of liquidity ratio and liquidity ratio. with the Net Fixed Financing Ratio (NSFR).