For financial regulators seeking to use regulatory requirements to manage risk in a banking system, there can be a … concern that such requirements crowd out efforts by banks to develop their own risk management systems. One way in which … regulators have attempted to solve this problem is to enable banks to use internal risk models to satisfy regulatory requirements …

) risk estimates with portfolio risk. We use loan performance as a direct measure of portfolio risk as well as less direct … market-based measures. Our results document that loan performance is highly correlated with AIRB risk weights and that, in … contrast, Basel I risk weights are not reflective of loan performance. We find that capital requirements under the AIRB …