Explanation:
Under the Basel II Internal Ratings-Based (IRB) approach, the credit risk capital requirement is calculated as:
Capital = EAD × (UL - EL)
Where:
However, for regulatory capital purposes under Basel II, the formula is typically:
Regulatory Capital = EAD × (WCDR - PD) × LGD
Where:
Given that:
We can calculate PD × LGD: EL = EAD × PD × LGD 4.2 = 200 × PD × LGD PD × LGD = 4.2 / 200 = 0.021 (or 2.1%)
For corporate exposures under Basel II IRB, the capital requirement is typically 8% of risk-weighted assets, and the risk weight is calculated using the IRB formula. However, based on the options provided and the relationship between EL and capital, the capital requirement is typically 4 times the expected loss for corporate exposures under certain assumptions.
Capital = 4 × EL = 4 × 4.2 = EUR 16.8 million
This corresponds to option C: EUR 16.8 million.
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A regulatory analyst at a large bank is preparing a report of the bank's credit risk capital for the current year and uses the Basel II IRB approach for making the calculation. As part of this process, the analyst identifies a portfolio of credit exposures of equal size that are held by borrowers with the same probability of default. The analyst has collected the following information about the portfolio:
| Exposure at default | EUR 200 million |
|---|---|
| 1-year expected loss on the portfolio | EUR 4.2 million |
What is the correct estimate of the Basel II credit risk capital that the bank should reserve for this portfolio?
A
EUR 8.4 million
B
EUR 12.6 million
C
EUR 16.8 million
D
EUR 25.2 million
E
EUR 33.6 million
F
EUR 37.8 million