Fitch Ratings just released a report on Basel II's internal-rating based (IRB) approach to measuring regulatory capital for credit risk. The study -- which is called Demystifying Basel II: A Closer Look at the IRB Measures and Disclosure Framework--looks at the technicalities of the IRB approach as well as explains the impact of recent policy decisions and changes to the framework. It also shows how the rating enhancement for particular asset portfolios would look in terms of the new approach.

Fitch also highlights some of the significant analytical issues for market participants to keep in mind when looking at new credit risk disclosures under Basel II, focusing mainly on corporate and retail exposures and not on the treatment of securitization and credit risk mitigation.

The report pointed out that the IRB framework will help provide stronger risk management practices for more sophisticated banks around the world. Its adaptation will also be generally regarded as a positive development in terms of ratings. "Fitch believes that, as compared with current standards, the Basel II ratios are an improved yardstick for assessing capital adequacy relative to risk," analysts wrote.

The rating agency also supports Basle II's more risk-sensitive capital requirements. It also favors the move by banks to a more systematic measure of credit risk and capital allocation such as utilizing internal economic assessments. Fitch also said that it will be looking more closely at how a bank predicts credit risk, how it uses stress analysis and how it allocates capital over the course of an economic cycle.

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