With confidence in RWA calculated using banks’ internal models declining, the Basel Committee on Banking Supervision has proposed a revised set of standardised approaches to a bank’s risk weighted credit, market and operational risk exposures.
Risk-weighted assets (RWA) play a key role in the capital regulation of banks. However, with both markets’ and authorities’ lacking confidence in RWA calculated using banks’ internal models declining, the Basel Committee on Banking Supervision has proposed a revised set of standardised approaches to a bank’s risk weighted credit, market and operational risk exposures and a floor for internally modelled RWA based on the standardised approach.
While the objective may be clear; to constrain variability across banks and the aggressive use of models to drive down risk weightings, the regulators and banks are still working through the detail in these proposals. With an estimated completion date of end 2015, time is fast running out to reach agreement and some provisional impact studies highlight the potential for significant increases in capital requirements accompanied by a fall in returns. However, until these proposals are finalised and placed in context with related reforms such as the Fundamental Review of the Trading book, it will be challenging for individual firms to understand exactly what impact these changes will have on their business line returns.
As banks of all sizes await the outcome of this international debate, they shouldn’t lose sight of what is happening to the RWA framework at a national level, especially if this could shape wider market expectations. For example in Switzerland FINMA - together with the big banks and with the support of the SNB - has conducted a comparison between RWA calculated using the model-based and standardised approaches. The results of this comparison, in addition to the measures already taken by FINMA and those expected at the international level, will be taken into account by a working group led by the Federal Department of Finance. However, “the SNB still considers it necessary that the big banks increase transparency with regard to RWA. Therefore, FINMA has now called on these banks to disclose the differences between calculations using the model-based and standardised approaches. The Swiss believe that such enhanced transparency is necessary to restore the credibility of model-based RWA and to strengthen market discipline”1.
If this increased disclosure requirement moves beyond being a Swiss finish to become the new market norm in other jurisdictions, large banks could find themselves with the extremely resource intensive challenge of having to run their internal models along-side a standardised RWA framework, analysing then defending any variations between the two.