What are the supervisory LGD values under Foundation IRB?

Question

AcadiFi · Accepted Answer

Under **Foundation IRB (F-IRB)**, banks estimate PD internally but use **supervisory values** for LGD, EAD (CCF), and maturity — simplifying implementation while maintaining some risk sensitivity.

**Supervisory LGD values for corporate, sovereign, bank exposures:**

| Exposure Type | F-IRB LGD |
|---|---|
| Senior unsecured | 45% |
| Subordinated | 75% |
| Covered bonds | 11.25% |
| Senior secured by financial collateral | adjusted via comprehensive approach (can reach 0%) |
| Senior secured by eligible physical/real estate | effective LGD scales with LGD* formula |

**LGD* formula for secured exposures:**
LGD* = LGD_U × (E − C*) / E + LGD_S × C* / E

where LGD_U = 45% (unsecured), LGD_S depends on collateral (e.g., 40% for CRE/receivables, 20% for other physical), E is exposure, C* is effective collateral value after haircuts and minimum collateralization thresholds.

Example: Coldharbour National has a $80M corporate loan to Milbrook Manufacturing, partially secured by $40M CRE collateral. Under F-IRB with LGD_U = 45%, LGD_S = 40% for CRE:
LGD* = 45% × ($80M − $40M) / $80M + 40% × $40M / $80M
= 45% × 0.5 + 40% × 0.5 = 42.5%

**Supervisory maturity under F-IRB:**
- Fixed at M = 2.5 years (except repos M = 0.5), simplifying capital calc

**Supervisory CCF (EAD factor):**
- Committed undrawn: 40%
- Unconditionally cancellable: 10% (Basel III final raised from 0%)
- Trade finance: 20–50% depending on maturity/structure

```mermaid
flowchart LR
  A[F-IRB Bank] --> B[Estimates PD]
  A --> C[Supervisory LGD 45%]
  A --> D[Supervisory M=2.5]
  A --> E[Supervisory CCF]
  B --> F[Capital calc]
  C --> F
  D --> F
  E --> F
```

F-IRB is common for mid-sized banks that have sufficient rating data for PD but lack granular LGD workout history. Basel III final eliminated F-IRB for exposures to large corporates, financial institutions, and equities — forcing standardized approach for those portfolios.

What are the supervisory LGD values under Foundation IRB?

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