Bank of Finland paper quantifies Basel II shortcomings
A Bank of Finland discussion paper has explored and quantified the shortcomings associated with the internal ratings-based (IRB) approach incorporated in the Basel II framework.
The Basel II framework required banks to have capital equivalent to at least 8% of their risk-weighted assets. It allowed banks to use an IRB approach to evaluate their risk weights.
This involved banks using an asymptotic single risk-factor model to assess their loan risks. When the model is correct, the authors say
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