Discuss the 'Credit Risk Assessment Approach' in Credit Risk Weighted Assets.

Under Basel II, Basel Committee on Banking Supervision has devised three approaches for calculation of credit risk weighted assets under Credit Risk Assessment. Standardized Approach to Credit Risk: The standardized approach has fixed risk weights which vary from 0 to 150 per cent, corresponding to various risk categories based on rating agencies. Loans which are unrated carry 100 percent risk weight. The approach has widened risk sensitivity by taking into account a broad range of collateral, guarantees and credit derivatives. The residential mortgage exposure carries a lesser risk weight related to Basel I. Foundation Internal Rating Based Approach: Credit risk under this approach is based on internal ratings of a bank instead of external credit rating agencies. The ratings correspond to risk characteristics of borrower and the transaction. Expected loss arrived at based on Probability of Default of borrower Loss Given Default, Banks exposure at Default and remaining Maturity of exposure. Probability of Default is a measure of (PD) likelihood that a borrower's default over a time horizon. Loss Given Default (LGD) computes the proportion of the exposure that will be lost if Defaults occurs. Exposures at Default (EAD) gives an estimate of loan amount outstanding at the time of default. Maturity (M) measures the remaining economic maturity of the exposure. Advanced Internal Rating Based Approach: It is an improved version of Foundation Internal Rating Based Approach. Under the Advanced IRB approach, Loss Given Default and Exposure at Default are estimated based on historical data by the bank itself.