Minimum Capital Requirements for Credit Risk

Irrespective of the materiality, exposures to central counterparties arising from over-the-counter derivatives, exchange traded derivatives transactions and securities financing transactions must be treated according to the dedicated treatment laid down in chapter 8 of The Counterparty Credit Risk (CCR) Framework . 11. IRB Approach: Risk Weight Functions 11.1 This chapter presents the calculation of risk weighted assets under the internal ratings-based (IRB) approach for: (i) corporate, sovereign and bank exposures; and (ii) retail exposures. Risk weighted assets are designed to address unexpected losses from exposures. The method of calculating expected losses, and for determining the difference between that measure and provisions, is described in chapter 15 . Explanation of the Risk-Weight Functions 11.2 Regarding the risk-weight functions for deriving risk weighted assets set out in this chapter: (1) Probability of default (PD) and loss-given-default (LGD) are measured as decimals (2) Exposure at default (EAD) is measured as currency (e.g. SAR), except where explicitly noted otherwise (3) ln denotes the natural logarithm (4) N(x) denotes the cumulative distribution function for a standard normal random variable (i.e. the probability that a normal random variable with mean zero and variance of one is less than or equal to x). The normal cumulative distribution function is, for example, available in Excel as the function NORMSDIST. (5) G(z) denotes the inverse cumulative distribution function for a standard normal random variable (i.e. the value of x such that N(x) = z). The inverse of the normal cumulative distribution function is, for example, available in Excelas the function NORMSINV. Risk-Weighted Assets for Exposures that are in Default 11.3 The capital requirement (K) for a defaulted exposure is equal to the greater of zero and the difference between its LGD (described in paragraph 16.82 ) and the bank’s best estimate of expected loss (described in paragraph 16.85 ). The risk- weighted asset amount for the defaulted exposure is the product of K, 12.5, and the EAD. Risk-Weighted Assets for Corporate, Sovereign and Bank Exposures that are not in Default Risk-weight functions for corporate, sovereign and bank exposures 11.4 The derivation of risk-weighted assets is dependent on estimates of the PD, LGD, EAD and, in some cases, effective maturity (M), for a given exposure. 11.5 For exposures not in default, the formula for calculating risk-weighted assets is as follows 11.6 Regarding the formula set out in paragraph 11.5 above, M is the effective maturity, calculated according to paragraphs 12.43 to 12.54 , and the following term is used to refer to a specific part of the capital requirements formula: