Bank regulatory arbitrage via risk weighted assets dispersion

Bank regulatory arbitrage via risk weighted assets dispersion

Increased dispersion of Risk Weighted Assets (RWA) troubles regulators as potentially undermining prudential supervision. We study the determinants of RWA/EAD (Exposure-At-Default) on data painstakingly compiled from Basel Pillar-Three for 239 European banks over 2007–2013. We improve on most previous studies, which consider instead RWA/TA (Total Assets). Indeed, Internal-Rating-Based (IRB) models allow lawful capital-saving Roll-Out effects which RWA/TA analyses disregard and likely misidentify as regulatory arbitrage. Instead, encapsulating Roll-Out effects, RWA/EAD avoids false positive identification. We find that regulatory arbitrage: (i) was present; (ii) likely materialized via risk weights manipulation with IRB models; (iii) was stronger at Advanced-IRB vs Foundation-IRB banks.

Giovanni Ferri and Valerio Pesic

Journal of Financial Stability

December 2017

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By |2018-01-01T00:00:00-08:00January 1st, 2018|Financial Regulation, Political Economy, Reference, Reforms|