European bank balance sheets are shrinking. Barclays Capital analysts note first-quarter declines at 15 of the 25 largest quoted banks in Europe, with banks reporting on average balance sheets 3% smaller at the end of March this year on an annualized basis than at the end of 2010. Remarkably, risk-weighted assets have declined even faster: by 8% on an annualized basis over the same period.
It would be heartening to see this as evidence of banks de-risking and perhaps calculating RWAs on the basis of reduced probability of default against a more stable economic backdrop than prevailed during the recession of 2007-09. Unfortunately, recent reductions in RWAs only draw attention to the fact that many banks also reported declines in RWAs during the recession.
Simon Samuels, analyst at Barclays Capital, expresses unease at the explanations coming from some banks for these latest RWA reductions. Talk of model changes and data cleansing inspires little confidence and only increases the suspicion that banks are somehow gaming the system, using probability-of-default inputs to their internal models that produce lower RWAs and hence lower capital requirements.
Clarity needed
Samuels now suggests: “Given the importance of risk weightings to the structure of the European bank sector, it is crucial that regulators and banks equip investors with clear, transparent and auditable risk weightings.” He adds: “It has got to a very sorry state whenever lower risk weightings – which of course should be a good thing – are viewed with suspicion and higher risk weightings are seen as somehow better.”
Andrew Stimpson, bank analyst at KBW, surveys how out of favour European bank stocks are by aggregating sell-side buy-and-sell recommendations. He finds that, with buys accounting for just 52% of analysts’ calls, banks remain among the least-loved large sub-sectors of the DJ Stoxx 600, below oil and gas, industrials, basic resources and health care. These doubts about banks’ RWA numbers may be one reason why.
