The European Banking Authority (EBA) published the result of its assessment of the consistency of risk-weighted assets (RWAs) across all EU institutions that use internal models for calculating capital requirements. The assessments cover credit risk for large corporate, institutions, and sovereign portfolios (collectively referred to as “low default portfolios” – LDP), as well as market risk. In line with previous years, the majority of risk-weights (RWs) variability can be explained by fundamentals.
In the LDP credit risk consistency assessment, a majority (61%) of the variability across banks can be explained by a few drivers: the proportion of defaulted exposures in the portfolio; the country of the counterparty; and the portfolio mix. For the remaining variability, the definition of default, especially “unlikely to pay”, saw the widest range of approaches. If low RW banks’ parameters were replaced by benchmarking parameters, RW would increase by 7.9% (compared with 7.5% in the 2015 LDP exercise) – European banks should still comfortably meet their capital ratio requirements under this scenario.
As for market risk models, a significant dispersion for all the risk measures is observed across banks. This is particularly prominent for traded credit and for more sophisticated measures, such as the Incremental Risk Charge (IRC) and All Price Risk (APR). Modelling choices (log-normal returns, basis risks, and volatility surfaces), data quality and missing risk factors drove this variability. Supervisors are planning further investigations in areas such as the cumulative materiality of missing risk factors, and the consistent representation of the migration effects and PD floors for IRC. VaR, IRC and APR are scheduled to be modified or replaced. The Expected Shortfall measure which will replace VaR had a lower variability.
In general, the EBA considered the findings consistent with previous studies as the increase in variation was due to a wider sample of banks. However, regulators still appear keen to take action to improve consistency within risk management processes within banks for the current and upcoming capital measures. For credit risks, EBA will likely suggest further actions to address outliers in the corporate and financial institutions portfolios. For market risks, a capital buffer may be suggested for certain modelling choices.