Answer-first summary for fast verification
Answer: The SA gives lower risk weights to unrated credits than to credits rated B+ or lower, which may incentivize Resource Bank to lend to unrated companies with poor credit quality.
**B is correct.** The Standardized Approach (SA) provides a 100% risk weight for unrated credits and 150% risk weight for credits rated B+ or lower. This creates a potential adverse selection and moral hazard risk, as banks like Resource Bank may be incentivized to lend to unrated companies with poor credit quality rather than rated companies with low ratings, since the unrated credits receive more favorable risk weights. **A is incorrect.** The A-IRB approach does have an explicit adjustment for maturity, while SA has some adjustments relating to short-dated exposures. Therefore, A-IRB would not undercapitalize long-dated exposures at Global Bank. **C is incorrect.** SA is not a modeled approach and therefore does not have correlation parameters. The Foundation IRB incorporates a correlation parameter chosen by the Basel committee, but not the SA. Even if high correlations exist among Resource Bank's oil and gas counterparties, it is not possible to know if they are captured in a non-modeled approach. **D is incorrect.** Under the A-IRB approach, the bank specifies the probability of default (PD), loss given default (LGD), and exposure at default (EAD). Even under the Foundation IRB, the bank still specifies the PD. The Basel committee does not specify PD parameters for A-IRB.
Author: LeetQuiz .
Ultimate access to all questions.
No comments yet.
A researcher at a national regulatory agency is examining the use of the standardized ratings-based approach (SA) and the advanced internal ratings-based (A-IRB) approach in determining credit risk capital. The researcher evaluates the implications of applying these approaches on two different banks, Global Bank and Resource Bank. Information about the credit exposures of the two banks is provided below:
Which of the following is the most appropriate conclusion for the researcher to reach?
A
The A-IRB approach does not adjust for maturity, which means that A-IRB could undercapitalize the long-dated exposures at Global Bank.
B
The SA gives lower risk weights to unrated credits than to credits rated B+ or lower, which may incentivize Resource Bank to lend to unrated companies with poor credit quality.
C
Model parameters used in the SA effectively capture the high default correlation that is likely to exist between Resource Bank's lending counterparties.
D
The A-IRB approach would require Global Bank to model the exposure at default while using a probability of default specified by the Basel committee.