The European Banking Authority (EBA) published today two reports on the consistency of risk weighted assets (RWAs) across all EU institutions authorised to use internal approaches for the calculation of capital requirements. The reports cover credit risk for large corporate, institutions, and sovereign portfolios (collectively referred to as "low default portfolios" - LDP), as well as market risk. The results confirm previous findings, with the majority of risk-weights (RWs) variability explained by fundamentals. These benchmarking exercises, conducted by the EBA on an annual basis are a fundamental supervisory and convergence tool to address unwarranted inconsistencies and restoring trust in internal models.
LDP Credit Risk exercise
The LDP credit risk report examines the different drivers leading to the observed dispersion across banks' models. Most of the results are broadly in line with previous LDP exercises, with 61% of the difference in variability explained by a few drivers (the proportion of defaulted exposures in the portfolio; the country of the counterparty; and the portfolio mix). The remaining variability could be attributed to differences in riskiness – i.e., idiosyncratic portfolio features, modelling assumptions and risk management practices used by banks, as well as supervisory practices. An analysis was performed to quantify the impact on RWs for banks with lower RWs. If banks' parameters were replaced by benchmarking parameters, RW would increase by 7.9 percentage points (7.5 percentage points in the 2015 LDP exercise).
In line with the EBA IRB roadmap, this exercise confirmed that the definition of default and the treatment of defaulted assets are key areas of supervisory attention. The EBA is currently finalising its Guidelines on the estimation of risk parameters, which are expected to be published by the end of November 2017.
Market Risk exercise
For market risk, the initial market valuation variability tends to be lower for interest rate portfolios due to more consistent practices across banks for modelling interest rate risk. In line with the previous exercises, a significant dispersion for all the risk measures is observed, particularly for more sophisticated measures, such as the Incremental Risk Charge (IRC) and All Price Risk (APR).
Modelling choices play an important role in explaining this variability, especially for the most complex risk measures. This calls for further investigations by supervisors in areas such as the materiality of risk factors not in VaR and the consistent representation of the migration effects for IRC on a low credit spread rates environment.
Note to the editors
These annual benchmarking exercises contribute to the work the EBA is conducting for improving the regulatory framework, increase convergence of supervisory practices and, thus, restoring confidence in internal models. The EBA has identified a number of options and published guidelines to address specific concerns, such as the report specifying the methodology assessment that competent authorities shall follow when assessing the compliance of an institution with the requirements to use the IRB approach and the guidelines on the application of the definition of default. In parallel, the exercises provide a regular supervisory tool based on benchmarks to support competent authorities' assessments of internal models and produce comparisons with EU peers.