A comprehensive explainer of the IRB approach to credit risk capital — covering Foundation vs. Advanced IRB, the capital formula, PD/LGD/EAD modelling, model governance, the output floor, and worked examples in the Irish bank context.
The Internal Ratings-Based (IRB) approach allows banks to use their own statistical models — rather than fixed regulatory weights — to estimate the credit risk of their loan portfolios and calculate the minimum capital they must hold. It is the most sophisticated of the three approaches available under the Basel III / CRR framework, and the one used by the largest Irish banks.
Under the Standardised Approach, a 75% risk weight applies to all retail exposures regardless of whether the borrower has a perfect credit history or is already in arrears. IRB allows banks with sophisticated risk models to use their own data-driven PD, LGD and EAD estimates, producing capital requirements that better reflect the actual risk of each portfolio.
IRB feeds PD, LGD and EAD into a supervisory formula (the Basel asymptotic single risk factor model) that produces a risk weight for each exposure. High-quality exposures with low PD attract lower capital requirements; riskier exposures attract higher. The aggregate RWA determines the bank's minimum capital requirement.
Using IRB is not automatic — banks must obtain ECB permission for each model, demonstrate their models are accurate and consistently applied, and pass ongoing validation standards. In return they may hold significantly less capital than the Standardised Approach on high-quality portfolios. The output floor (CRR III) now caps the total benefit.
| Framework | Introduced | Key IRB Change |
|---|---|---|
| Basel II (2004) | 2007–2008 | First introduction of IRB — Foundation and Advanced approaches. Banks could hold significantly less capital than SA if models were approved. |
| Basel II.5 / CRR I | 2011–2014 | Added trading book and securitisation capital charges. IRB corporate models largely unchanged but supervisory scrutiny increased post-crisis. |
| Basel III / CRR II | 2014–2021 | Capital quality requirements; leverage ratio; LCR/NSFR. IRB models subject to targeted review (TRIM) by ECB from 2016. |
| Basel III finalisation / CRR III | 2025–2030 | Output floor (72.5% of SA) phases in — caps total RWA benefit of IRB. A-IRB removed for certain exposure classes. LGD and PD floors tightened. Most significant IRB reform in 20 years. |
Banks choose their credit risk measurement approach on a portfolio-by-portfolio basis, subject to regulatory permission. The choice determines how much internal modelling the bank does and how much it relies on supervisory parameters.
Fixed regulatory risk weights prescribed by CRR. No bank-specific modelling. External ratings (where available) may influence the weight.
Bank builds and uses its own PD models (approved by ECB). LGD and CCF/EAD values are prescribed by supervisory rules, not modelled by the bank.
Bank builds and uses approved models for all three inputs — PD, LGD, and EAD/CCF. The most capital-efficient approach but requires the most data and model infrastructure.
| Parameter | Standardised (SA) | Foundation (F-IRB) | Advanced (A-IRB) |
|---|---|---|---|
| PD | Fixed regulatory weight (no PD) | Own model — ECB approved | Own model — ECB approved |
| LGD | Embedded in RW | Supervisory values (prescribed) | Own model — ECB approved |
| EAD / CCF | Embedded in RW | Regulatory CCFs | Own model — ECB approved |
| Maturity (M) | Not applicable | Standard 2.5 years | Estimated from cashflows (1–5yr) |
| Capital formula | Fixed weights × EAD | Basel supervisory formula | Basel supervisory formula |
| Minimum data history | None | 5 years PD data | 7 years PD; 7 years LGD/EAD data |
The Basel IRB capital formula is based on the Asymptotic Single Risk Factor (ASRF) model — a mathematical framework that derives the probability of a large unexpected loss on a portfolio given a single systematic risk factor (the state of the economy). Understanding the formula is essential to understanding why IRB risk weights behave as they do.
R is not estimated by the bank — it is prescribed by Basel for each exposure class. It represents how correlated each borrower's default probability is with the overall economy. A higher R means a more concentrated portfolio where losses cluster in economic downturns.
| Exposure Class | Asset Correlation (R) | Formula / Note |
|---|---|---|
| Corporate (general) | 12–24% | R = 0.12×(1−e−50×PD)/(1−e−50) + 0.24×(1−(1−e−50×PD)/(1−e−50)). Decreases as PD rises — high-PD obligors are more idiosyncratic. |
| Retail — Residential Mortgage | 15% (fixed) | Fixed correlation reflecting the systematic nature of property price cycles. High correlation vs. other retail — house prices move together across borrowers. |
| Retail — Qualifying Revolving | 4% (fixed) | Low correlation — consumer credit card defaults are more idiosyncratic; diversification benefit is highest here. |
| Retail — Other (SME retail) | 3–16% | PD-dependent formula similar to corporate but with different parameters. Irish SME retail uses this class. |
| SME Corporate (revenue <€50m) | 12–24% less size adj. | Same as corporate formula but with a size adjustment that reduces R for small firms — they are less correlated with the macro cycle than large corporates. |
Enter PD, LGD and select the exposure class to see the IRB risk weight and capital requirement. The formula is the full Basel supervisory formula — not an approximation.
The IRB capital formula contains several mathematical functions that can look intimidating. This tab explains each one in plain language with simple everyday examples — no prior maths knowledge required.
The normal distribution is the famous "bell curve". If you measured the heights of 10,000 Irish adults, most would cluster around the average (say 175cm), with fewer and fewer people at the extremes (very tall or very short). That bell-shaped pattern is a normal distribution.
The function N(x) — called the cumulative normal distribution — answers the question: "What proportion of the population sits at or below value x?" It always returns a number between 0 and 1 (a probability).
In the IRB formula, N(...) converts a combined stress score into a conditional default probability — the probability of default given that the economy is in a severe stress scenario. The output is always between 0% and 100%.
G(p) is simply the reverse of N(x). Instead of asking "what proportion sits below x?", it asks: "If p proportion of the population sits below this point, what is the point?"
In the formula, G(PD) converts the bank's estimated PD (a probability like 1.5%) into a position on the normal curve. A PD of 1.5% maps to approximately G(0.015) = −2.17 — meaning this obligor sits 2.17 standard deviations below the point where defaults become the norm.
And G(0.999) is used to represent the 99.9th percentile stress scenario — a once-in-a-thousand-year economic shock. It equals approximately 3.09. This is the level of systemic stress the bank must be able to survive.
R measures how much individual borrowers' fortunes move together with the overall economy. If R is high, borrowers tend to default at the same time (in a recession). If R is low, defaults are more spread out and random — one borrower defaulting tells you little about the next.
A higher R produces a higher, fatter tail in the loss distribution — meaning the worst-case outcome is much worse than the average, and the bank needs proportionally more capital. This is why even low-PD mortgage portfolios require meaningful capital: R = 15% means correlated losses in a downturn, which is exactly what happened in Ireland.
In the formula, R appears in the expression √(R/(1−R)) × G(0.999) — this term adds the 99.9th percentile economic shock, scaled by how strongly borrowers are exposed to it. Higher R makes this term larger, increasing capital requirements.
The full expression inside N( ) is:
This combines two things: the borrower's own default tendency (G(PD)) and the stress from the economy (G(0.999)). Think of it as adding up two forces pulling toward default:
The result fed into N() gives the conditional default probability — the probability of this borrower defaulting given the economy is in extreme stress. This is always higher than the unconditional PD.
This dramatic jump from 2.8% to 22.8% in a stress scenario is why IRB capital requirements can look high even for moderate-risk borrowers. The formula is designed to capture the tail behaviour of a correlated portfolio under extreme stress.
K is the capital requirement as a fraction of EAD. The formula subtracts PD from the stressed default probability — this is deliberate and important.
The bank already prices its expected loss (= PD × LGD × EAD) into its loan pricing and provisions — it charges a margin for the losses it expects to incur on average. Capital is only required for unexpected losses — the extra losses above and beyond what was expected that could threaten solvency.
So N(...) − PD = stressed default probability minus expected default probability = the unexpected default probability. Multiplied by LGD, this gives the unexpected loss rate. Multiplied by EAD, this gives the unexpected loss in cash terms, which is what the bank must hold as capital.
The maturity adjustment (MA) scales capital upward for longer-dated exposures. The logic is straightforward: the longer a loan has to run, the more time there is for the borrower's credit quality to deteriorate before the bank can exit the position.
The MA formula is (1 + (M−2.5) × b) / (1 − 1.5 × b), where M is the effective maturity in years and b is a function of PD. It is anchored at 1.0 when M = 2.5 years (the standard assumption). Loans shorter than 2.5 years get a reduction; loans longer than 2.5 years get an increase.
Retail exposures — mortgages, credit cards, personal loans — are exempt from the maturity adjustment because the Basel committee determined that retail portfolios are managed on a portfolio basis where individual loan maturities matter less than portfolio-level behaviour.
The formula tells a single coherent story in five steps:
This is the bank's best estimate of how likely this borrower is to default in a normal year — the TTC PD from the IRB model. For our Irish SME: PD = 2.8%.
Apply the asset correlation (R) and the 99.9th percentile economic shock. The borrower's default probability jumps from 2.8% to 22.8% in the stressed scenario — because they are correlated with the economy (R = 15.8%) and the economy is in severe distress.
Subtract the unconditional PD (2.8%) from the stressed default probability (22.8%) = 20.0%. This is the unexpected default rate — the part not already priced into loan margins and provisions.
20.0% unexpected default rate × 38% LGD = 7.6% unexpected loss rate (pre-maturity adjustment). This is K — the capital required as a percentage of EAD.
Multiply K by the maturity adjustment (1.117 for a 3.2-year loan) = 8.5% final capital rate. Multiply by 12.5 to get the risk weight = 106%. Multiply by EAD to get RWA. Multiply RWA by 13.5% to get the CET1 capital required.
IRB PD models must estimate the through-the-cycle (TTC) probability of default over a one-year horizon for each obligor or rating grade. This is distinct from the point-in-time PD used for IFRS 9 — IRB PD must reflect the long-run average default rate across a full economic cycle, not current conditions.
Represents the long-run average default rate for a rating grade across a full economic cycle. Deliberately smoothed to prevent procyclical swings in capital requirements — if TTC PD rose and fell with the economy, banks would need most capital exactly when they can least afford it.
Reflects current economic conditions and forward-looking forecasts. Rises in recessions and falls in recoveries — deliberately procyclical because IFRS 9 wants provisions to reflect the current economic environment.
IRB banks build internal rating scales where each grade has an assigned TTC PD. The rating process maps borrower characteristics to a grade, and historical default experience for that grade establishes the PD. There are two main modelling approaches:
Logistic regression or similar technique maps borrower attributes (LTV, DTI, bureau score, income) to a probability score. Common for retail portfolios where volume allows statistical calibration. The score maps to a rating grade and the grade has a PD. Irish banks use scorecard models for mortgage and consumer lending.
For corporate and SME lending, quantitative factors (DSCR, leverage ratios, revenue trend) are combined with qualitative analyst judgement (management quality, sector outlook, competitive position). A hybrid model provides a starting point that analysts can override within documented bounds. AIB and BOI use hybrid models for their SME and mid-market corporate books.
| Requirement | Rule | Irish Bank Implication |
|---|---|---|
| Minimum data history | At least 5 years of internal default data; at least 1 year of stress period included | Post-2008 Irish default data is now mature; banks had to rebuild models using crisis-era defaults which significantly raised calibrated PDs vs. pre-crisis estimates |
| PD floor | Minimum PD of 0.03% for non-defaulted exposures under CRR | Prevents artificially low PDs for very high quality exposures; most Irish retail exposures are well above this floor |
| Long-run average calibration | PD must represent the long-run average default rate, not a point-in-time estimate | Banks must demonstrate calibration window includes stress; ECB TRIM reviews challenged models that excluded or underweighted the 2009–2012 Irish downturn |
| Margin of conservatism (MoC) | EBA GL/2017/16 requires banks to add a margin of conservatism to PD estimates to reflect data limitations and model uncertainty | Significant uplift required where data is sparse (e.g. low-default portfolios, new product types); MoC directly increases RWA |
| Use test | IRB ratings must be used in internal credit decisions, pricing, and risk management — not built solely for regulatory capital | Banks must demonstrate rating system is embedded in credit approval, limit setting, and risk appetite frameworks — pure "capital model" that is not used for business decisions fails the use test |
| Annual review | PD models must be reviewed at least annually; significant changes require ECB notification or approval | Model lifecycle management is a significant ongoing cost; model changes that increase capital typically require notification only; changes that reduce capital require formal ECB approval |
LGD is the expected proportion of an exposure lost if default occurs, after recoveries from collateral, guarantees, and obligor assets. For A-IRB, banks build their own LGD models subject to regulatory floors and stress requirements. For F-IRB, supervisory LGD values are prescribed. LGD is often the single largest driver of IRB capital for secured portfolios.
Average realised LGD across the full historical observation period including all economic conditions. Used as the starting point for LGD estimation but not the final regulatory LGD — must be adjusted to reflect downturn conditions.
LGD calibrated to reflect stressed collateral values and extended recovery timelines during an economic downturn. EBA guidelines (GL/2019/03) require banks to identify the economic downturn period and calibrate LGD accordingly. For Irish banks this is the 2009–2012 period where property values fell 50%+ peak to trough.
CRR III introduced binding input floors for LGD — minimum values below which a bank's own estimate cannot go regardless of its model output. These floors apply to A-IRB and prevent banks from using aggressive collateral valuations to drive LGD to near zero.
| Exposure Type | LGD Floor (CRR III) | Practical Impact for Irish Banks |
|---|---|---|
| Unsecured corporate / institutional | 25% | Senior unsecured: many Irish corporate models were at or above this floor already given poor recovery rates post-2008 |
| Residential real estate secured | 10% | High-quality Irish prime mortgages (low LTV, high credit quality) had modelled LGDs below 10% before CRR III; floor now binding for this segment |
| Commercial real estate secured | 15% | Irish CRE LGDs from the 2008–2012 experience were well above this floor; less binding for existing models |
| Unsecured retail | 30% | Consumer and personal loans; floor generally not binding given retail LGDs are typically 40–60% |
| Other physical collateral secured | 15–20% | Vehicles, plant, equipment — collateral value deterioration means LGDs above floor in most cases |
Bank identifies that the obligor has defaulted. The workout process begins — the bank attempts to recover as much of the outstanding exposure as possible through a combination of obligor cashflows, collateral realisation, guarantee enforcement, and legal proceedings.
Over the resolution period (which for Irish PDH mortgages can be 3–7+ years), the bank collects all cashflows from the defaulted exposure — partial payments, property sale proceeds, guarantee recoveries. All cashflows must be discounted back to the default date at the bank's cost of capital (or contractual EIR).
Legal costs, receiver fees, valuation costs, property maintenance, estate agent fees, and other direct workout costs are deducted from gross recovery proceeds. For Irish mortgage defaults these costs are substantial — legal proceedings alone can run to €20,000–€50,000 per case.
The realised LGD is the proportion of EAD not recovered in present value terms. This realised LGD feeds into the historical dataset used to calibrate the model. Banks need large samples of fully resolved defaults (i.e. workout complete) to build reliable LGD models.
Where a default has not yet been fully resolved (workout ongoing), the bank must estimate the final LGD using the best available information. With Irish mortgage resolution timelines often exceeding 5 years, banks have large portfolios of "work-in-progress" defaults where realised LGD is not yet known — requiring careful incomplete workout adjustments in the model calibration.
Exposure at Default (EAD) is the expected outstanding balance at the time an obligor defaults. For drawn term loans it equals the current balance. For revolving facilities and undrawn commitments, a Credit Conversion Factor (CCF) must be applied to estimate how much will be drawn before default occurs — and empirical evidence shows borrowers in financial distress draw heavily on available credit before defaulting.
The CCF converts an undrawn commitment into an EAD equivalent. It reflects the empirical observation that obligors approaching default draw down available revolving credit and committed facilities — often aggressively — in the period leading up to default. Ignoring this produces a material understatement of exposure.
| Facility | F-IRB CCF | Typical A-IRB CCF | Driver |
|---|---|---|---|
| Unconditionally cancellable lines | 0% | 0–10% | Bank can withdraw facility immediately; no committed exposure. However A-IRB banks observe some drawdown even on cancellable lines in practice. |
| Committed revolving ≤ 1yr maturity | 20% | 25–50% | Short-dated committed facilities; bank obliged to fund drawdown requests until maturity |
| Committed revolving > 1yr | 50% | 60–85% | Longer committed facilities; higher drawdown risk as bank cannot cancel for extended period; observed in Irish SME corporate data |
| Overdraft facilities | 75% | 65–90% | High CCF — overdraft users in financial difficulty use full limit as last resort; commonly observed pre-default in Irish retail data |
| Credit cards | 75% | 80–95% | Very high — cardholders exhaust available credit in the large majority of default cases; Irish consumer data confirms this pattern |
| Standby letters of credit | 50% | Bespoke | Performance vs. financial letters of credit differ; probability of being called drives the EAD estimate |
IRB model governance is as important as model accuracy. The ECB requires banks to demonstrate not only that their models produce good estimates, but that those models are subject to robust independent validation, used consistently in business decisions, and reviewed and updated regularly. Poor governance is a standalone reason for the ECB to withdraw or restrict IRB permissions.
The credit risk modelling team builds, documents, and maintains the IRB models. Responsible for data quality, methodology choices, calibration, and initial testing. At Irish banks this typically sits within the Chief Risk Officer function — not in business lines.
An independent model validation team (separate from development) reviews every model before it goes live and annually thereafter. They assess discriminatory power, calibration accuracy, stability, and documentation quality. Findings are reported to the Model Risk Committee. ECB expects genuine independence — the validation team must be able to veto or restrict model use.
Internal audit reviews the overall model governance framework — are policies followed, is validation independent, are findings acted upon? Reports to the Audit Committee. The ECB also conducts its own supervisory reviews (TRIM, targeted model investigations) which sit alongside the bank's internal governance.
| Test | What It Measures | Common Metric | Acceptable Range |
|---|---|---|---|
| Discriminatory Power | Does the model rank obligors correctly — do high-PD obligors default more than low-PD ones? | Gini coefficient / AUROC | >60% Gini (good); >70% (strong) |
| Calibration Accuracy | Are the predicted PDs close to the observed default rates in historical data? | Binomial test; Traffic light approach | Predicted ≈ observed within confidence interval |
| Stability (PSI) | Has the portfolio's score distribution shifted since the model was built? A shifted portfolio may be mis-calibrated. | Population Stability Index (PSI) | PSI <0.10 stable; 0.10–0.25 monitor; >0.25 investigate |
| Concentration Risk | Is the model over-reliant on a single risk driver that could fail in specific scenarios? | Variable importance; sensitivity analysis | No single variable >40% of predictive power (typical guide) |
| Back-testing (LGD) | Do actual loss outcomes on resolved defaults match the model's predictions? | Mean absolute error; coverage ratio | Predicted LGD >= realised LGD (conservative) |
Bank engages informally with its Joint Supervisory Team (JST) before submitting a formal application. Flagging methodology choices and data gaps early avoids costly late-stage rejections. For a new IRB model this engagement can span 6–12 months.
The bank submits a complete application package including: model documentation, validation report, methodology paper, data quality assessment, back-testing results, use test evidence, and governance framework documentation. The package typically runs to hundreds of pages per model.
The ECB sends examiners on-site (or conducts remote review post-COVID) to review data, systems, and governance. They interview model developers, validators, and business users. The use test is assessed here — can the bank demonstrate the model is used in credit decisions, pricing, and ICAAP?
The ECB issues findings — classified from minor observations to material findings requiring model adjustment before approval. The bank responds with a remediation plan. For significant findings, re-submission is required. The process from application to approval typically takes 18–36 months for a complex portfolio model.
The ECB grants approval — often with conditions (e.g. margin of conservatism add-on until more data is available, or a requirement to re-submit after 2 years of additional data). Conditions are recorded in the SREP decision and must be remediated within the agreed timeline.
The Basel III output floor is the most significant change to the IRB framework in 20 years. It caps the total capital benefit a bank can obtain from using IRB models by requiring that IRB-based RWA cannot fall below 72.5% of the RWA that would result from applying the Standardised Approach. It phases in from 2025 to 2030.
| Year | Floor Level | Effective from |
|---|---|---|
| 2025 | 50% | First year of phase-in under CRR III (EU implementation) |
| 2026 | 55% | |
| 2027 | 60% | |
| 2028 | 65% | |
| 2029 | 70% | |
| 2030 | 72.5% | Fully phased in — permanent floor |
| Portfolio | IRB RW (typical) | SA RW | Floor (72.5% × SA) | Floor Binding? |
|---|---|---|---|---|
| Irish prime mortgage (LTV <60%) | ~10–15% | 20% (SA LTV band) | 14.5% | Often binding — low IRB RWs |
| Irish prime mortgage (LTV 60–80%) | ~15–22% | 35% | 25.4% | Frequently binding post-2025 |
| Buy-to-let mortgage | ~25–45% | 75% | 54.4% | Partially binding |
| Irish SME corporate | ~70–100% | 85–100% | 62–72% | Rarely binding — IRB near SA |
| Large corporate / institutional | ~60–90% | 100% | 72.5% | Partially binding |
Two illustrative Irish exposures — a residential mortgage and an SME corporate loan — showing the full IRB capital calculation from PD/LGD/EAD inputs through the supervisory formula to final RWA and capital requirement, with comparison to the Standardised Approach.
| Step | Input / Output | Notes |
|---|---|---|
| EAD | €300,000 | Fully drawn term loan — no CCF required |
| PD | 0.40% | TTC PD from A-IRB mortgage model; well-seasoned prime borrower |
| LGD | 14% | Downturn LGD — stressed property values, 3yr recovery time, legal costs included; above 10% floor |
| Asset Correlation (R) | 15% | Fixed for residential mortgages under Basel — reflects property price cycle correlation |
| Maturity Adjustment | N/A (retail) | Retail exposures exempt from maturity adjustment |
| Capital Requirement K | 0.97% | = LGD × [N(√(1/0.85)×G(0.004) + √(0.15/0.85)×G(0.999)) − PD] |
| IRB Risk Weight | 12.1% | = K × 12.5 |
| IRB RWA | €36,300 | = 12.1% × €300,000 |
| SA RWA (comparison) | €105,000 | 35% SA RW for LTV 60–80% residential mortgage |
| Floor threshold (72.5% × SA) | €76,125 | = 72.5% × €105,000 |
| Effective RWA (post-floor) | €76,125 | Floor is binding — IRB RWA (€36,300) < floor threshold (€76,125) |
| CET1 Required (post-floor) | €10,277 | = €76,125 × 13.5% |
| CET1 Without Floor | €4,901 | = €36,300 × 13.5% — what A-IRB model alone would produce |
| Step | Input / Output | Notes |
|---|---|---|
| EAD | €1,850,000 | €1,800,000 drawn + (75% CCF × €200,000 undrawn RCF) = €1,800,000 + €50,000 (A-IRB CCF model output; F-IRB would use 50%) |
| PD | 2.80% | TTC PD from A-IRB corporate SME model; BB− grade; DSCR 1.1×, moderate leverage |
| LGD | 38% | Downturn LGD — partial CRE security (€600k value); remainder unsecured; above 25% unsecured floor |
| Asset Correlation (R) | 15.8% | Corporate formula: R = 0.12×(1−e−50×0.028)/(1−e−50) + 0.24×(remaining weight) ≈ 15.8%; SME size adjustment reduces R slightly vs. large corporate |
| Maturity Adjustment (MA) | 1.182 | M = 3.2 years; b(PD) = (0.11852 − 0.05478 × ln(0.028))² = 0.0492; MA = (1 + (3.2−2.5) × 0.0492) / (1 − 1.5 × 0.0492) = 1.182 |
| K (pre-maturity) | 8.14% | = LGD × [N(√(1/0.842)×G(0.028) + √(0.158/0.842)×G(0.999)) − PD] |
| K (post-maturity) | 9.62% | = 8.14% × 1.182 |
| IRB Risk Weight | 120.2% | = 9.62% × 12.5 |
| IRB RWA | €2,224,000 | = 120.2% × €1,850,000 |
| SA RWA (comparison) | €2,312,500 | 85% SME retail SA weight (if retail SME) or 100% corporate weight × EAD |
| Floor threshold (72.5% × SA) | €1,676,563 | = 72.5% × €2,312,500 |
| Floor Status | Not binding | IRB RWA (€2,224,000) > floor threshold (€1,676,563) — IRB is higher; floor does not constrain |
| CET1 Required | €300,240 | = €2,224,000 × 13.5% |
IRB is central to how AIB and Bank of Ireland manage their capital — it determines their RWA density, capital requirements, return on equity, and the economics of their lending businesses. Understanding the Irish banks' IRB journey requires understanding the post-2008 model rebuilding, TRIM, and the CRR III headwinds now facing them.
AIB holds A-IRB permissions for residential mortgages, SME and mid-market corporate, and consumer lending. Their IRB models have been substantially rebuilt since 2008 and recalibrated following TRIM. The bank has explicitly quantified the output floor impact — estimating a multi-year RWA headwind of several billion euros as the 72.5% floor phases in on the mortgage book.
BOI holds A-IRB permissions for Irish and UK residential mortgages, corporate lending, and SME. The UK book is approved under PRA rules (which differ from ECB requirements in some areas — particularly LGD floors and downturn definitions). Maintaining parallel ECB/PRA approved models for equivalent portfolios adds significant model governance cost.
PTSB uses the Standardised Approach for its residential mortgage book. Building and maintaining A-IRB models requires substantial investment in data infrastructure, model teams, and ECB engagement — infrastructure that PTSB's smaller balance sheet makes harder to justify economically. The output floor has reduced the relative disadvantage of SA vs. A-IRB for mortgage books specifically.
| Finding Area | Common TRIM Issue | Impact on Irish Banks |
|---|---|---|
| Default definition | Inconsistent application — DPD resets, premature cure, inadequate UTP identification | Required complete harmonisation with EBA GL/2016/07; historical default datasets required reconstruction; PD calibrations increased |
| PD calibration | Insufficient margin of conservatism; calibration window excluded or underweighted stress period | MoC add-ons applied; calibration windows extended to include 2009–2012; PDs rose materially for Irish SME and mortgage models |
| LGD downturn | Long-run average LGD used instead of downturn LGD; recovery costs understated | Downturn LGDs increased, particularly for Irish CRE and partially secured exposures; direct capital impact |
| Use test | IRB ratings not consistently used in credit decisions; business overrides of model ratings too frequent and poorly documented | Required embedding of rating systems in credit approval processes; override governance frameworks strengthened |
| IT infrastructure | Model implementation errors; inconsistent data feeds; manual adjustments without governance | Significant IT investment required; some model approvals delayed pending system remediation |
A shift from ex ante to ex post — what it means for credit risk capital models. Two coordinated publications on 30 March 2026 fundamentally change how IRB credit risk model changes are approved in the EU.
Under CRR, banks approved to use the Internal Ratings-Based (IRB) approach must seek supervisory approval for any material change to their credit risk models before implementing it. This applies to changes in PD, LGD, CCF models or their rating system design.
The existing regime has created a significant bottleneck. A high volume of applications for material model changes has piled up at the ECB and NCAs, causing lengthy queues. Banks have had to maintain two versions of a model — old and new — simultaneously while waiting for regulatory sign-off.
The first layer of reform comes from the EBA, which has published revised Regulatory Technical Standards (RTS) on materiality assessment for IRB model changes:
Greater reliance on quantitative thresholds. A change is material only if it breaches defined numerical bounds — making classification more objective and predictable.
Qualitative triggers limited to genuine redevelopments: model rebuilt from scratch, risk parameters re-estimated wholesale, or Definition of Default changes significantly.
Routine model maintenance — data updates, recalibrations within thresholds — moves to notification only, unless it crosses a quantitative trigger.
References to approaches removed under CRR3 (IRB for equity, AMA for op risk) have been deleted to align with current prudential framework.
For material changes that still require ECB approval, the ECB is changing how it grants that approval. Effective 1 October 2026:
| ⛔ Old Process (Ex Ante) | ✅ New Process (Ex Post) |
|---|---|
| Submit application to ECB | Submit complete application package to ECB |
| Wait for full supervisory review (often lengthy) | Internal control function confirms model compliance |
| Maintain old and new model in parallel throughout | Bank implements change shortly after submission |
| Only implement change after ECB decision | ECB conducts targeted post-implementation review |
| Every material change triggers an on-site investigation (IMI) | On-site investigations reserved for higher-risk cases only |
The shift to ex post is not unconditional. Four key safeguards apply:
Bank's internal control function must credibly confirm the revised model meets regulatory requirements and operational readiness.
Where model change results in lower risk weights, regulatory capital benefit is subject to a floor until ECB assessment.
ECB on-site model investigations targeted at higher-risk cases: models with outlier behaviour, weaknesses in changing macro conditions, or flagged as sensitive.
For sensitive cases, ECB retains option to require standard prior approval — banks must wait for on-site investigation before implementation.
EBA publishes revised RTS on IRB materiality. New quantitative-first materiality criteria published. ECB simultaneously announces its new ex post supervisory approach.
ECB's new ex post approval process takes effect. Banks may implement material credit risk model changes shortly after submitting complete application — subject to internal sign-off.
Targeted on-site investigations & floor releases. As ECB completes targeted reviews, capital floors can be lifted — allowing banks to fully recognise RWA benefit of improved models.
This reform is explicitly part of the ECB's "Next-level supervision" project, which aims to make SSM supervision more efficient, effective and risk-based across the board. Internal model approvals were identified as one of the highest-priority areas for reform.
Other parallel strands include: streamlining SREP methodology, revising on-site inspection processes, developing tiered approach to supervisory findings, and increasing use of SupTech tools. The IRB model reform is one of the first major structural changes to become concrete and go-live.
Briefing prepared from official ECB and EBA publications dated 30 March 2026. Sources: ECB Press Release 30.03.2026, EBA RTS on IRB Materiality (revised), CRR/CRR3, ECB Next-Level Supervision.