There’s a wide variation in how banks assess the probability of defaults, which can have a significant impact on the amount of capital they hold against those risks, suggests new research.
The Basel Committee on Banking Supervision published its first report Friday examining the regulatory consistency of risk-weighted assets (RWAs), which found “considerable variation across banks in average RWAs for credit risk in the banking book.” It notes that while most of that variation can be explained by differences in the composition of banks’ assets, as the regulators intended when they developed a more risk sensitive capital framework, “there is also material variation driven by diversity in bank and supervisory practices.”
The study found that banks are generally consistent in their assessment of the relative riskiness of borrowers, but that there are differences in the levels of estimated risk that banks assign to these assets (expressed in terms of the probability of default and the losses a default would create).
“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 two percentage points from a 10% risk-based capital ratio benchmark,” it says; although the capital ratios for most banks fall within a narrower range.
The report finds that there are notable outliers evident in each asset class, but that the sovereign asset class shows 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,” it says.
The committee notes that the study, which is a part of its overall effort to ensure consistent implementation of the new Basel III capital framework, also includes a preliminary discussion of potential policy options that it could pursue in seeking to minimize excessive variations.
“While some variation in risk weightings should be expected with internal model-based approaches, the considerable variation observed warrants further attention,” said Stefan Ingves, chairman of the Basel Committee and governor of Sveriges Riksbank.
“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,” he added. “The committee will be considering similar exercises to monitor consistency in capital outcomes and assess improvement over time.”
The study draws on supervisory data from more than 100 major banks, as well as additional data on sovereign, bank and corporate exposures collected from 32 major international banks as part of a portfolio benchmarking exercise.