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An Assessment of the Internal Rating Based Approach in Basel II

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  • Simone Varotto

    () (ICMA Centre, University of Reading)

Abstract

The new bank capital regulation commonly known as Basel II includes a internal rating based approach (IRB) to measuring credit risk in bank portfolios. The IRB relies on the assumptions that the portfolio is fully diversified and that systematic risk is driven by one common factor. In this work we empirically investigate the impact of these assumptions by comparing the risk measures produced by the IRB with those of a more general credit risk model that allows for multiple systematic risk factors and portfolio concentration. Our tests conducted on a large sample of eurobonds over a ten year period reveal that deviations between the IRB and the general model can be substantial.

Suggested Citation

  • Simone Varotto, 2008. "An Assessment of the Internal Rating Based Approach in Basel II," ICMA Centre Discussion Papers in Finance icma-dp2008-04, Henley Business School, Reading University.
  • Handle: RePEc:rdg:icmadp:icma-dp2008-04
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    File URL: http://www.icmacentre.ac.uk/files/dp200810.pdf
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    References listed on IDEAS

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    1. Lopez, Jose A., 2004. "The empirical relationship between average asset correlation, firm probability of default, and asset size," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 265-283, April.
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    Cited by:

    1. Ali, Syed Babar, 2012. "Quality of Internal Risk Rating Frameworks at Commercial Banks in Pakistan," MPRA Paper 55117, University Library of Munich, Germany.

    More about this item

    Keywords

    Basel II; Internal Rating Based Approach; Credit Rating; Credit Risk;

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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