A bank engages in derivative trades with other counter-parties . Depending on market conditions the bank can either make money or lose money on these trades . Whenever you engage in such a trade there is always a risk the other counter-party might not hold up their end of the trade . This risk is called Counter-party Credit Risk .

In order to ensure we don’t have banks failing the bank regulators require the banks to hold capital against the trades they have on their books .

Internal Model Method (IMM) is one type of methodology used to measure regulatory capital requirements of the Bank . Specifically CCR and CVA capital requirements.

It provides a more risk sensitive way of measuring capital requirements taking into consideration different Counter-party risk scenarios.

What do I mean by risk sensitive way of measuring capital ?

In order to calculate the capital requirements we model the price of each trade under different scenarios in the future and calculate the exposure we have to each counter-party .

Using the exposure numbers we calculate the amount of capital we have to hold for counter-party Credit Risk .

That is what IMM is in simple terms .