Project Finance: Slotting vs. A-IRB/F-IRB
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Given the new Basel regulation, Specialized Lending has its own exposure class and can continue to to utilize the full range of regulatory approaches; Standardized, Slotting, FIRB and AIRB. Each approach will require more data to achieve, but also lead to lower capital requirements
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Standardized approach is suitable for limited exposure towards Specialized Lending
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Slotting approach is suitable for institutions with limited internal data to build FIRB or AIRB PD models, but results in little risk differentiation given the stringent regulatory categories to be covered in a slotting model. The maturity risk differentiation provides capital relief for loans in the last phase until maturity
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FIRB and AIRB allows the highest level of risk differentiation with PD models primarily build on internal observations (default or shadow rating models). In case of joint PD and LGD simulation models, various FSA expressed their expectation towards banks to utilize external loss and recovery information during the model build process (various form e.g. rank-ordering, calibration, MoCs). The capital benefit for AIRB towards FIRB has been reduced with the new Basel regulation given more sensitive Foundation LGD treatment, but it still provides a Risk Weight benefit of around 40 percent in higher recovery rate project finance segments (banks data quality and granularity can impact the benefit due to additional MoCs).
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A noteworthy oddity potentially affecting the choice of modelling approach: In the slotting approach, the risk mitigating effect of ECA coverage cannot be recognised. I.e. for transactions with ECA coverage, there is a significant over-estimation of risk in the slotting approach. On the other hand, FIRB and AIRB as well as the standardized approach do allow for consideration of ECA coverage.