CREDIT RISK – STANDARDIZED APPROACH & CREDIT RISK – ADVANCED APPROACH
In this article, we are going to discuss the standardized and advanced approach to credit risk management and the CAIIB STUDY MATERIAL 2023 available for the same.
The Indian Institute of Banking & Finance administers the Certified Associate of India Institute of Bankers exam (IIBF). The EXAM is held twice a year. CAIIB strives to provide advanced information in areas such as Treasury Management, Risk Management, Balance Sheet Management, Credit Management, International Banking, Economic Analysis, and so on, to help people make better decisions.
Risk is the possibility of losing money or having a negative consequence as a result of taking a certain activity. Uncertainty refers to the inability to predict what will occur in the future; the larger the uncertainty, the higher the risk. Risk management is a term used to describe the process of a person managing his or her decisions which entails maximizing projected profits while taking into account the hazards and risk tolerance of the investors. Risk is what allows for profit to be made. There wouldn’t be any reward if there was no danger to your ability to handle it successfully. A risk-reward trade-off exists for each decision. There should be a chance of profit whenever there is a risk of loss.
The process of discovering, assessing, and controlling threats to a company’s capital and profits is known as risk management. These dangers, or risks, could come from a variety of places, such as financial uncertainties, legal liability, and strategic considerations. Errors in administration, mishaps, and natural disasters are all possibilities. Threats to information technology and data risks, as well as risk management measures to mitigate them, have risen to the top of the priority list for many organizations/ companies that have digitized. As a result, a risk management strategy is becoming more comprehensive. Different processes are used by businesses to identify and control threats to their digital assets, such as customers’ personally identifiable information, and confidential corporate data which is also known as intellectual property.
Credit risk- standardized approach:
The word “standardized approach” refers to a collection of credit risk measurement techniques recommended under Basel II, which establishes capital adequacy criteria for banks.
Banks are obligated to utilize ratings from external credit rating organizations to quantify the required capital for credit risk under this strategy. This is the only technique that regulators in many countries permitted during the initial phase of Basel II implementation. The Basel II agreement recommends allowing banks to choose between two main techniques for calculating their credit risk capital requirements. The third option is to use internal ratings. Under the Basel III: Finalizing Post-Crisis Reforms, changes to the standardized approach to credit risk were implemented.
The proposed standardized approach comprised components of the Basel II standardized approach, as updated by the 2009 upgrades, as well as certain aspects of Basel III and additional ideas in BCBS consultative papers.
The following are some of the highlights of the Final Rule’s uniform approach:
- More risk-aware approaches to stock exposures, derivatives, and repo-style financing transactions, as well as some commercial real estate risks.
- Using the gross-up method or a new streamlined supervisory formula method for securitization exposures (SSFA)
- Capital benefits for cleared derivatives and repo-style transactions involving a financial institution counterparty central (CCP)
- Requirements for qualitative and quantitative disclosure for banking organizations with consolidated assets of $50 billion or more
The uniform method applies to all of the entities listed above, i.e., all financial firms subject to the Final Rule. As a result, advanced approach banks are subject to the regulations.
Credit risk- advanced approach:
The advanced approach proposal includes Basel III criteria as well as BCBS upgrades from 2009 and later consulting papers. The following are some of the advanced approaches described in the Final Rule:
- Improving the internal model methodology (IMM) for counterparty exposures and a new capital charge for credit value adjustment (CVA)
- Minimum capital requirements for cleared transactions with eligible and non-qualified counterparties in the center.
- For exposure to particular assets, the asset value correlation multiplier has been increased.
- SSFA was implemented for securitization exposures.
- Citations to external credit ratings have been removed.
The advanced techniques apply to businesses that are subject to the Final Rule and have the following assets:
- Consolidated assets of $250 billion or more
- Foreign exposures on the balance sheet of more than $10 billion
To help you out with this module of credit risk standardized approach and advanced approach, we have compiled the CAIIB STUDY MATERIAL provided by the IIBF. These notes would help you understand the concepts better.
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