25 January 2018

VoxEU: Comparability of Basel risk weights in the EU banking sector is questionable

Regulatory reviews have begun to address risk weight heterogeneity issue. The Regulatory Consistency Assessment Programme (RCAP) exercise of the BCBS, the EBA’s review of consistency of risk-weighted assets exercise, and the ECB’s Targeted Review of Internal Models (TRIM) exercise are all examples. According to the EBA’s benchmarking report (EBA 2017a), for example, the country of the reporting bank and the respective countries of the counterparties are important drivers of risk weight variability.

Action as well as words show this topic is taken seriously by regulators. For example, in many countries macroprudential supervisors have established risk weight floors (ESRB 2017).

Authors‘ analysis is based on the datasets from the EBA transparency exercises. This public database is made up of bank-specific data from more than 130 banks, in 24 countries in Europe. This represents around 70% of total EU banking assets (European Banking Authority 2015).

The dataset has the advantage of granularity – exposures and risk weight are broken down by banks, asset classes, destinations of the credit and calculation method (IRB versus standardised approach), as well as time. This granularity allows them to compare portfolio-by-portfolio risk weight determined by a number of factors.

They find that a large share of risk weight variability can be explained by differences in the underlying risk, but there are statistically significant and economically important differences relating to the country in which the bank is headquartered. This provides evidence that standards are implemented differently from jurisdiction to jurisdiction. This finding is robust to a range of alternative specifications.

Recent efforts by supervisors to lower risk weight variability are important, most notably the EBA benchmarking exercise and the ECB’s TRIM exercise. The measures, focusing specifically on the euro area, should be extended to encompass also non-euro area countries in order to reduce unwarranted risk weight variability.

In addition, their results support regulatory floors for risk weights as envisaged under Basel IV, and efforts by supervisors to harmonise banks’ Pillar III requirements. Their findings can inform the ongoing policy debate about the complexity of regulation. Complex rules require great effort – possibly too much effort – from supervisors to enforce standards consistently, and to monitor the banks that are subject to the rules.

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