The Basel Committee proposed adding IDRC to specific risk which through two forms:

• An internal model of default risk tailored to 99.9th percentile at one-year time horizon similar to the IRB approach
• When the internal model is unavailable, either standardized or current exposure approach of calculating specific risk similar to that of Basel I.

Things to Remember

• Incremental Default Risk Charge (IDRC) is a measure introduced by Basel 2.5 to capture the incremental default risk of specific risk in the trading book.
• Basel II.5 aimed to enhance the capital requirements for specific risk in the trading book by introducing IDRC.
• The IDRC is calculated based on a one-year time horizon and is tailored to the 99.9th percentile of the distribution of potential losses.
• Internal Rating-Based (IRB) approach allows banks to use their internal models to calculate IDRC based on their specific portfolios and risk profiles.
• The standardized approach and current exposure approach are alternatives provided for calculating IDRC when internal models are not available.