Severity over quantity. Drivers of supervisory capital add-ons in internal ratings-based models
Banks use their internal models to estimate capital requirements in a risk-sensitive way, subject to a set of rules laid down in banking regulation. However, these models are not flawless as the usage of models suffers from imperfections, such as oversimplifications or wrong assumptions. As a result, risks may be underestimated. This is particularly troublesome, where models are used to assess risks to banks’ solvency. In this paper we address an important gap in the literature with regard to such model risk.
