# Standardized Approach

In the standardized approach, the risk weights are defined by the regulator according to external ratings. The risk weights range from 20% for AAA- to AA-rated notes up to 350% for BB+ to BB= notes, and full deduction of capital for those notes that are rated below BB-. For unrated exposures, there are various provisions extending from full deduction from capital to the "look-through" treatment for senior exposures. The look-through approach consists of determining the risk weight for senior unrated exposures as the average risk weights of underlying exposure of the pool of asset backing the securitization is known.

# IRB Approaches

The rating-based approach (RBA) relies on supervisory risk weights. The supervisory risk weights depend on external ratings, the granularity of the underlying pool of assets, and the seniority in the position held by the bank. The risk weights to be used under RBA range from 7% and up to 100% for BBB- and below exposures. When the underlying assets form a nongranular portfolio, the minimum risk weight is 20%.

The internal assessment approach (IAA) relies on inputs provided by banks. The capital charge is given by the supervisory formula (SF). The supervisory formula relies on key elements that determine the credit risk according to the seniority level of notes. There are five bank-supplied inputs:

• the IRB capital charge had the underlying exposures not been securitized (named *K^)*

• the tranche's credit enhancement level *(L)* and thickness *(T)*

• the pool's effective number of exposures *(N)*

• the pool's exposure weighted average loss-given-default (LGD).

The inputs *K^, L, T* and *N* are defined below.

*• K* is the ratio of the IRB capital requirement including the EL portion for the underlying exposures in the pool to the exposure amount of the pool.

• The credit enhancement level *(L)* is measured (in decimal form) as the ratio of the amount of all securitization exposures subordinate to the tranche of interest to the amount of exposures in the pool. It refers to the protection provided to the tranche considered, since all subordinated tranches have a lower priority claim and are hit by portfolio losses first.

• Thickness of exposure (7) is measured as the ratio of the nominal size of the tranche of interest to the notional amount of exposures in the pool. The thickness is the difference between two consecutive credit enhancement levels. The higher the thickness, the riskier the tranche.

• The effective number *(N)* of exposures in the pool is the ratio of the sum of squared exposures to the sum of exposures9 or:

As a substitute, banks may use the instead the inverse of the largest exposure. • The exposure weighted average LGD is the average of LGD of each individual underlying exposure with weight equal to the ratio of its exposure to total exposure of the pool.

The capital charge is calculated as *S(L + T) - S(L),* where *S* is the function of the supervisory formula.

The supervisory formula is equal to *L,* the credit enhancement, when L < *K* or becomes a function of all inputs when *K < L.* The capital charge is the increment between the capital charge if the bank were exposed to all exposures below *L* + 7 minus the capital charge assigned to the subordinated notes *(L),* which is consistent with seniority rules across tranches.

When the credit enhancement is lower that the capital charge of the underlying pool under IRB approaches, the capital charge is *S(L + T) - S(L),* but *S(X)* becomes a function of all inputs. When the capital charge of the underlying pool under IRB approaches is lower than the credit enhancement, regulators make an adjustment for the fact that the IRB treatment of the underlying pool would result in a capital lower than credit enhancement.