The Calibration of the IRB Supervisory Formula – A Case Study

31 Pages Posted: 10 Oct 2023

See all articles by Simone Casellina

Simone Casellina

European Banking Authority

Fabio Salis

Cerved Group

Giovanni Tessiore

Cerved Group

Roberto Ugoccioni

Intesa SanPaolo Spa

Franco Varetto

Politecnico di Torino - Italy

Date Written: September 26, 2023

Abstract

The level of capital requirement generated by the IRB approach depends crucially on the asset correlation, a parameter that enters the regulatory risk weight formula and is determined by the Regulators. Several studies have estimated the asset correlations and found that the empirical values are materially lower than the regulatory calibration included in the Basel framework. However, the simple comparison between different estimates of this parameter does not easily translates into a clear economic interpretation. In this paper, we use detailed data from Italian banks to show how to extract from the regulatory risk measures easily interpretable figures i.e. the Worst-Case Default Rate (WCDR) and the Worst-Case Loss (WCL) and we show how the asset correlation influences these measures. We then provide a rationale for the regulatory calibration in terms of corrections to well-known limits of the underlying models like the assumption of perfect granularity. We claim that our approach can provide a better understating of the IRB risk measures fostering their transparency and reliability but also simplifying the comparison among different banks. We apply the proposed approach exploiting some data sources (publicly available and proprietary). As the data used is mainly referred to the Italian system and, in particular, to only two banks, the empirical results obtained are meant just to provide a practical example.

Keywords: Bank Capital, Regulation, Basel 2, Credit Risk, Asset Correlation, Value-at-Risk

JEL Classification: C15, G21, G32

Suggested Citation

Casellina, Simone and Salis, Fabio and Tessiore, Giovanni and Ugoccioni, Roberto and Varetto, Franco, The Calibration of the IRB Supervisory Formula – A Case Study (September 26, 2023). European Banking Authority Research Paper No. 17, Available at SSRN: https://ssrn.com/abstract=4584063 or http://dx.doi.org/10.2139/ssrn.4584063

Simone Casellina (Contact Author)

European Banking Authority ( email )

20 avenue André Prothin CS 30154
One Canada Square, Canary Wharf
92927 Paris, La Défense CEDEX E14 5AA
France

Fabio Salis

Cerved Group ( email )

Giovanni Tessiore

Cerved Group ( email )

Italy

Roberto Ugoccioni

Intesa SanPaolo Spa ( email )

Piazza P. Ferrari 10
P.O. BOX 8319
Milan, 20121
Italy

Franco Varetto

Politecnico di Torino - Italy ( email )

Corso Duca degli Abruzzi n.24
Torino, Torino 10129
Italy

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