  The Basel II internal ratings-based (IRB) approach to capital adequacy for
credit risk implements an asymptotic single risk factor (ASRF) model.
Measurements from the ASRF model of the prevailing state of Australia's economy
and the level of capitalisation of its banking sector find general agreement
with macroeconomic indicators, financial statistics and external credit
ratings. However, given the range of economic conditions, from mild contraction
to moderate expansion, experienced in Australia since the implementation of
Basel II, we cannot attest to the validity of the model specification of the
IRB approach for its intended purpose of solvency assessment. With the
implementation of Basel II preceding the time when the effect of the financial
crisis of 2007-09 was most acutely felt, our empirical findings offer a
fundamental assessment of the impact of the crisis on the Australian banking
sector. Access to internal bank data collected by the prudential regulator
distinguishes our research from other empirical studies on the IRB approach and
recent crisis.
