IRBA for Everyone: Unlocking Big Opportunities for Small Banks under CRR III

With the finalised Capital Requirements Regulation that came into force on 1st January 2025 (CRR III), banks can implement a tailored partial use of the Internal Ratings-Based Approach (IRBA) and thus achieve a more efficient use of capital in conjunction with improved risk and capital management. d-fine has been an experienced partner for banks in the IRBA transformation for over 20 years with more than 100 IRBA projects completed successfully and offers full support in this area.

While exceptions to the application of the IRBA on the entire portfolio previously had to be justified, CRR III now offers extensive options for the choice of the rating approach for individual exposure classes. This allows banks to adopt a selective approach focusing on exposure classes that are particularly suited for the development of internal rating models and offers substantial RWA (risk-weighted assets) reductions. Typically, these are primarily the risk exposures from the retail business. With a corresponding Permanent Partial Use (PPU) strategy1, the implementation of the IRBA also offers attractive advantages for smaller financial institutions.

In the German banking market in particular, some institutions have recognized this opportunity and are preparing to switch to internal models. This is also motivated by the backdrop of a possible low-interest rate environment, in which efficient capital utilization will become essential. Importantly, introducing the IRBA also leads to significantly improved process and data quality – an advantage that extends far beyond risk management and often opens up new opportunities on the market.

Case Studies

The following case studies illustrate the potential with regards to the CET1 ratio (Common Equity Tier 1 capital ratio) by transferring individual or several exposure classes to the IRBA. A regulatory condition for the use of the IRBA is that individual exposure classes are to be transferred to the IRBA together with all positions they contain. In addition to exposures from private individuals, the retail exposure class also includes exposures of less than € 1 million from small and medium-sized enterprises (SMEs).

Case Study: German ‘Bausparkasse’ (Building Society)
Building societies refinance themselves through building society deposits, which often results in a liability surplus in a low-interest rate environment. In the past, this surplus was mainly invested in safe securities from financial institutions.

The portfolio of a building society mainly comprises building society loans (retail exposures) and various financial investments. While retail business is a homogeneous block of mortgage loans, financial investments are typically very heterogeneous. Efficient use of internal models (rating procedures for estimating PD and LGD) is therefore usually only possible in retail business. […]

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