The European Banking Authority issued a report this week on the regulatory consistency of risk-weighted assets in the EU banking sector, which identified some discrepancies requiring further analysis.

The EBA's second interim report covered RWA consistency in low-default portfolios (LDP), consisting of central governments, credit institutions, and large corporates, all of which typically have low default rates. The goal was to identify differences in RWA outcomes and analyze whether new regulation is needed in the area. The study was based on a Hypothetical Portfolio Exercise involving 35 banks in 13 European countries, conducted in the second half of 2012, along with data on real exposures from the banks.

“This is an important step in a series of exercises the EBA is conducting with the aim of ensuring consistency in the calculation of RWAs across the EU,” Andrea Enria, chairperson of the EBA, said in a statement. “Some national supervisory authorities are already taking actions based on the outcomes of this work.”

The study found relevant differences in the scope of the application of internal models to LDP counterparts, such as application of the standardized approach, permanent exemption, and roll-out; probabilities of default (PDs) and loss given defaults (LGDs) parameters for the same exposure to a counterparty; the definition of default and computation of the default rate used for the calibration of internal models; and the computation of risk weights and expected losses on defaulted assets, according to information released by the EBA this week.

Discrepancies also were noted in methods of computing maturity parameters, Credit Conversion Factor parameters, and the reporting practices among the banks reviewed. EBA officials pointed out that it could be difficult to compare outcomes given differences in how banks handle minimum PDs, LGDs, and add-ons to the risk weights computed with internal models.

While the EBA noted some differences were expected, the report revealed some “unwarranted variations” caused by bank and supervisory practices and other factors. The EBA found discrepancies among banks even in hypothetical identical exposures, and noted new regulatory standards may be needed as part of its implementation of the Capital Requirements Directive and Capital Requirements Regulation. The regulator highlighted four general areas needing further study:

Enhanced supervisory disclosure and banks' transparency on RWA-related data;

More rigorous validation and monitoring processes of banks' internal models;

Additional guidelines and technical standards regarding specific LDP issues;

New benchmarks or constraints for internal ratings-based risk parameters.

The EBA plans to finalize a market risk benchmarking exercise on the trading book and publish a review of risk weights for SMEs and the residential mortgage sector by the end of the year.

“The EBA will provide appropriate disclosure of RWA-related information and coordinate further work to restore market confidence in risk sensitive measures of capital adequacy,” Enria said.

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