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Internal ratings-based (IRB) approach
The internal ratings-based approach to credit risk allows banks to model their own inputs for calculating risk-weighted assets from credit exposures to retail, corporate, financial institution and sovereign borrowers, subject to supervisory approval. Under foundation IRB, banks model only the probability of default. Under the advanced IRB approach, banks can also model their own loss given default (LGD) and exposure-at-default (EAD) levels. LGD is the absolute amount of money lost if a borrower defaults while EAD is the amount a bank is exposed to at the time of the same default.
Under the Basel III package finalised in December 2017, banks can no longer use the advanced IRB approach for exposures to financial institutions or corporates with consolidated annual revenues of more than €500 million.