Page 39 - Banking Finance May 2021

ARTICLE

INTERNAL RATING

BASED APPROACH:

A TOOL IN CREDIT

RISK MANAGEMENT

C redit Risk is defined as a potential risk that a bank 1. Standardised Approach and

borrower or counterparty will fail to meet its
2. Internal Rating Based (IRB) Approach:
obligations in accordance with agreed terms. It
I.
Foundation Internal Rating Based (FIRB) Approach,
can also be due to the deterioration of
creditworthiness of a debt instrument issuer or even in down II. Advanced Internal Rating Based (AIRB) Approach.
gradation of credit rating of a pool of credit portfolio. The
goal of credit risk management is to maximize a bank's risk- Why internal rating based approach?
adjusted rate of return by maintaining credit risk exposure In the standardized approach, the risk weights for different
within the acceptable levels. If we closely watch any Bank's exposures are specified by the regulator. To determine the
composition of risk-weighted assets we can find that major risk weights for the standardized approach, the bank can
contributor is credit risk. take the help of external credit rating agencies that are
recognised as eligible by Reserve Bank of India. In this
The Basel II Framework presents two approaches for approach banks were relying mechanically on external
calculating credit risk capital charge in a continuum of rating and the granularity, as well as risk sensitivity with
increasing sophistication and risk sensitivity: respect to the expertise of individual bank, was absent. On
the contrary in IRB each bank can have its model with
About the author approval from the regulator and a bank with robust credit
monitoring mechanism can save precious capital with lower
Ranjan Kumar Sahoo risk-weighted assets.
Chief Manager and Faculty,
Union Bank of India Internal Rating Based (IRB) Approach
The IRB approach allows banks, subject to the approval of

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