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SSM: Banks brace for punishment on credit risk, sovereign debt

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-600

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.

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