65. Credit risk is the risk of losses arising from a borrower or counterparty failing to meet its obligations as they fall due. Each bank should assess all its credit exposures and determine whether the risk weights applied to such exposures under the regulatory standardised approach for credit risk (Standardised Approach) are appropriate for the inherent risk of the exposures. Each bank should have the ability to assess credit risk at the portfolio level as well as at the exposure or counterparty level.

66. To ensure that each bank has sufficient capital allocated for credit risk, each bank should compare their capital consumption under two methods for all credit exposures across all asset classes: (i) the Standardised Approach and (ii) an estimation under the foundation internal-rating based approach (F-IRB) in the Basel Framework (“IRB approach: risk weight functions”, CRE31).

67. The Central Bank recognises that some banks may not have appropriately calibrated probability of defaults (PDs) for the calculation of the F-IRB approach. In the absence of such calibration, banks should rely on their 1-year PD used for IFRS provisioning purposes. Each bank should undertake this comparison at asset class level, where higher F-IRB numbers indicate additional required capital. Drivers of material differences between the two approaches should be explained.

68. If a bank uses credit risk mitigation techniques (CRMT), it should analyse and evaluate the risks associated to such mitigation under Pillar 2 risks measurement. The bank should analyse potential effects, the enforceability and the effectiveness of such CRMT, in particular in the case of real estate collaterals in order to estimate residual credit risk with prudence.