4 Min Read
(Repeat for additional subscribers)
July 18 (Reuters) - (The following statement was released by the rating agency)
The Basel III leverage ratio should be able to capture more risks by including off-balance sheet exposures, Fitch Ratings says. A potential simplification in the calculation of risk-weighted assets (RWAs) raised in a recent Basel discussion paper could also help reduce underestimated risks from the use of internal models. These two initiatives should improve the consistency of both risk-based and non-risk-based approaches to bank capital, and in turn help restore market confidence.
In contrast to traditional leverage metrics, the leverage ratio set out by the Basel Committee last month will force banks not only to hold capital against all assets - even those carrying minimal risk - but also bring in exposure accounted for off-balance-sheet. Banks must weight loan commitments at 100% unless the facilities are unconditionally cancellable at any time, in which case a 10% weighting applies. Derivatives must also be included gross of collateral and reverse repos without netting in most circumstances to capture the magnitude of these risks.
These adjustments are also important as they help to adjust for differences in accounting standards. For example, US GAAP has derivatives offsetting rules that result in exposures being reported net, rather than gross under IFRS. The Basel III leverage ratio should therefore be more comparable across banks globally than metrics based purely on unadjusted balance sheet totals. It should also be more useful for analysis once banks have fully disclosed consistent information, including the differences between financial statement assets and leverage ratio denominators.
But leverage is a blunt measure, and ignores the extreme variation in risk among different asset classes. Unfortunately, the significant dispersion in RWAs calculated using the internal ratings based (IRB) approach undermines investor trust and confidence in a risk-weighted approach. Recent studies by Basel confirmed the substantial variance in trading and banking book risk weights.
Although most of the difference in the overall asset weighting can be explained by different asset class mixes, some differences arise from supervisory decisions and from banks' choice of models and assumptions allowed by Basel and national regulators. This reduces the comparability of capital ratios calculated using internal models.
It is also challenging to compare banks using the IRB approach with those using the standardised approach. Some regulators bridge the gap between the two methodologies with risk-weight floors or by introducing benchmarks as suggested in the Basel discussion paper. These give greater flexibility than the standardised approach, but reduce RWA variability and complexity. Other simplification options include limiting national discretions in the internal model calculations and using a standardised approach in combination with a leverage ratio. We expect that differences at least among eurozone banks will reduce when the ECB is established as a single supervisor.
The best answer will not always come from standardisation of risk measurement, especially for complex transactions. The Basel framework recognises that not all variations should be viewed negatively, and aims to reduce rather than eliminate the differences to improve simplicity and comparability. Flexibility can prevent a build-up of systemic risk due to all banks acting in a similar way. We make allowances for RWA variability in our analysis, including assessment of leverage as well as risk-weighted metrics.
One of the keys, however, is to improve the quality and consistency of disclosure so that important differences can be better understood and assessed. Further disclosure around risk-weighted assets is one of the key recommendations by the Enhanced Disclosure Task Force.