15. The IRB Shortfall: where IFRS 9 provisions meet CET1
A bank books €100m of extra provisions and its CET1 barely moves. That is the IRB shortfall at work: the gap between regulatory expected loss and the provisions actually booked.
Credit Risk, IFRS 9
A bank adds €100m of IFRS9 provisions and its CET1 don't move: that is the IRB shortfall.
Every IRB bank measures its credit losses twice.
- One is regulatory expected loss: PD × LGD × exposure value, one year ahead, on a long-run average PD and a downturn LGD, under A-IRB.
- One is the IFRS 9 provision, the expected credit loss (ECL): point-in-time, driven by macro forecasts. Twelve months in Stage 1, lifetime in Stage 2 and 3.
The Article 159 of the CRR3 requires to compare them.
➡️ Provisions minus regulatory: expected loss. Negative is an AIRB shortfall, positive an AIRB excess.
An AIRB shortfall is deducted from Common Equity Tier 1 capital (CET1) in full, no cap.
An AIRB excess is added back to the Tier 2, up to 0.6% of IRB risk-weighted assets.
❗️So an extra €100m of Stage 1 IFRS9 ECL is free in capital terms for a bank in AIRB shortfall: the P&L impact the retained earnings, but the AIRB shortfall shrinks by the same amount and at the end the CET1 is not moving.
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