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European banking: Risk-weighted assets doubts

Investors fear they cannot rely on banks’ calculations of their own risk-weighted assets.

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."

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