Apart from standardizing the numerator for banks’ solvency ratio (capital), the eurozone and the Basel Committee on Banking Supervision are going to analyse and, where necessary, harmonise the denominator (risk-weighted assets).
Philippe Bordenave, chief operating officer at BNP Paribas
The SSM’s judgement about whether or not there is excess variation in the calculation of risk-weighted assets between banks for similar portfolios is pending as it plans to review 7,000 models over four years. The UK, US and Basel have become more wary of the internal ratings-based (IRB) approach to calculate bank capital requirements for credit risk, arguing excessive variance between bank models is, at times, motivated by a desire to flatter capital ratios rather than a legitimate difference of opinion on credit risk.
The SSM has the means to be hawkish in tackling this variance in the IRB approach in the name of reducing country and lender arbitrage. This could have profound consequences for banks’ capital planning, risk management and exposure requirements that could constrain the profitability of certain loan portfolios, such as real estate. But eurozone officials have made few pronouncements on the issue and have not sought in public to promote the standardized approach over internal models.
Philippe Bordenave, chief operating officer at BNP Paribas, explains: “It is interesting that for the first time we will get one cross-country supervisor with the data, competency and authority to compare risk models and decide the legitimacy of this approach. I think the SSM is aware of the risks of any blunt and overly simplistic rules and calculations in the event a capital floor is imposed on IRB models.”
Julie Dickson, SSM board member, is tight-lipped: “We are in constant contact with financial institutions that are using models, and on a regular basis, banks are making changes after our input at the 129 institutions we supervise. We are taking those lessons into account when we respond to model-approval requests, and there is much interaction between the SSM and banks on this front.”
One area of risk-weighting controversy in both the standardized and the IRB model is sovereign debt. Germany is pushing to impose a ceiling on banks’ holdings of their home-country debt and/or raise minimum capital requirements allocated for such exposures. For risk-management purposes, regulators and supervisors agree. At present, eurozone regulations impose no limit on government bond holdings and in the standardized regime the highest rated benefit from a zero risk weighting. The proposal, which has already been publicly rebuked by Italian prime minister Matteo Renzi, is aimed, in part, to cut the links between sovereigns and banks that proved toxic during the eurozone crisis in southern Europe. The stakes are high. Italian banks, for example, hold €410 billion in domestic government bonds.
The SSM is studying policy proposals on this issue. Dickson explains: “There is a fair bit of agreement that a zero risk weighting is not appropriate. There are a number of options about how to deal with this. When you study a major change and seek to transition to a new regime, you don’t want to create another problem in the process. There is a lot of support behind this effort at the Basel Committee level.”