05 July 2013

Basel Committee issues report on the regulatory consistency of RWAs in the banking book

There is considerable variation across banks in average RWAs for credit risk in the banking book. The study published today finds that most of the variation in RWAs can be explained by broad differences in the composition of banks' assets, reflecting differences in risk preferences as intended under the risk-based capital framework. However, there is also material variation driven by diversity in bank and supervisory practices.

Through a portfolio benchmarking exercise, the study found a high degree of consistency in banks' assessment of the relative riskiness of obligors. That is, there was a high correlation in how banks rank a portfolio of individual borrowers. Differences exist, however, in the levels of estimated risk, as expressed in probability of default (PD) and loss-given-default (LGD), that banks assign. These differences drive the variation in risk weights attributable to individual bank practices, and could result in the reported capital ratios for some outlier banks varying by as much as 2 percentage points from a 10% risk-based capital ratio benchmark (or 20 per cent in relative terms) in either direction, although the capital ratios for most banks fall within a narrower range.

Notable outliers are evident in each asset class, with the corporate asset class showing the tightest clustering of banks around a central tendency, and the sovereign asset class showing the greatest variation. The low-default nature of the benchmark portfolios and the consequent challenges in obtaining appropriate data for risk estimation may be one factor contributing to differences across banks, especially for banks' estimates of LGDs in the sovereign and bank asset classes.

The report also includes a preliminary discussion of potential policy options that the Committee could pursue in seeking to minimise excessive practice-based variations. The Committee is conscious of the need to ensure that the capital framework retains its risk sensitivity, while at the same time promoting improved comparability of regulatory capital calculations by banks.

Commenting on the report, Stefan Ingves, Chairman of the Basel Committee and Governor of Sveriges Riksbank, said: "While some variation in risk weightings should be expected with internal model-based approaches, the considerable variation observed warrants further attention. In the near term, information from this study on the relative positions of banks is being used by national supervisors and banks to take action to improve consistency. In addition, the Committee is using the results as part of its ongoing work to improve the comparability of the regulatory capital ratios and to enhance bank disclosures. The Committee will be considering similar exercises to monitor consistency in capital outcomes and assess improvement over time."

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