Advanced Internal Rating-Based (AIRB)
Candlefocus EditorAIRB systems are based on a set of pre-defined criteria for a financial institution's loan portfolio and use internal models for assessing creditworthiness of customers. These models aim to measure the probability of default from a customer and how much money the bank will be able to recover from them in case of a default. These criteria ensure that the internal credit ratings accurately reflect the specific risk factors and are capable of providing a comprehensive assessment of a customer's risk level. Through careful analysis, AIRB systems can give an accurate picture of a customer's likelihood of success and the expected repayment likelihood in case of a default.
The AIRB system helps minimize the amount of capital needed by a financial institution to protect itself against default risk by focusing on the specific risk factors that are important. This allows a bank to reduce the amount of capital it has to set aside since the higher risk exposures are isolated and appropriately managed. Since AIRB systems rely on internal modeling, the bank's risk ratings are more accurate and reliable than if solely based on external ratings.
Overall, AIRB systems provide a comprehensive and accurate approach for assessing the credit worthiness of customers and managing the risk levels of a financial institution. By using internal models to accurately isolate risk areas and downplay lesser risk concerns, a bank is able to set aside appropriate capital reserves, reducing overall capital requirements and improving decision-making capabilities. AIRB systems can be an invaluable tool for financial institutions looking to manage and decrease risk levels.