## 1. Overview of Key Concerns Resulting from Current RWAs Calculation Practices

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### Major themes and scope
- Covers four main sections:
  - "1. Overview of Key Concerns Resulting from Current RWAs Calculation Practices" (page 7)
  - "2. Main Factors of Differences in RWA Densities across Jurisdictions and Banks" (page 13)
  - "3. Minimum, Median, and Maximum Risk-weights Attributed to Categories of Credit Risk" (page 21)
  - "4. Some Policy Options to Revisit the RWA Framework" (page 33)
- Supplementary items: Figures 1–17, Boxes 1–2, Appendices I–III.
- Time coverage referenced in figures: "1998–2011" and "1996–2010".

### Key findings: concerns and market implications
- Concerns summarized: inadequate, inconsistent, non-transparent, and non-comparable capital measurement practices.
- Possible market consequences if RWAs are distrusted:
  - Market participants may re-calculate banks' capital ratios (most likely downwards) and disregard regulatory reported ratios.
  - Market participants could stop using risk-based capital ratios and turn to the leverage ratio.
  - Investors may require higher capital ratios to compensate for perceived understatement of RWAs.
  - Investors could restrict lending to banks for which they have doubts about reported capital adequacy.
- Paper objectives:
  - Discuss the importance of RWAs in the regulatory capital framework.
  - Highlight main concerns and controversy surrounding RWA calculations.
  - Identify key drivers behind differences in RWA calculations across jurisdictions and business models.
  - Outline options to restore confidence in banks’ RWA numbers.
- Study scope excludes: a comprehensive analysis of the best way to measure risk or predict losses; determination of the optimal amount of capital per unit of risk; and a comparison of the respective merits of the leverage and risk-based capital ratios.

### Comparability evidence and headline statistics
- Sample: 50 systemically important banks (SIBs) across Asia Pacific (“Asia”), Europe (“EU”), and North America (“NA”).
- Observed capital metric patterns:
  - Global Average CT1 to RWAs: 11.0%
  - TCE/TA Global Average: 4.9%; EU 3.5%; NA 5.9%; AP 5.8%
  - Core Tier 1 Equivalent (TCE/RWA) Global Average: 11.0%; EU 10.6%; NA 10.5%; AP 11.9%
- RWA density (RWAs as percent of TAs) trends:
  - North America average RWA/TA: 57%
  - Europe average RWA/TA: 35%
  - Asia average RWA/TA: 51%
- Sub-sample of 14 banks reporting a 9 percent Core Tier 1 ratio:
  - Leverage Ratio varied between 3 percent (Europe and Asia Pacific) and 7 percent (North America).
  - RWA density varied between 23 percent and 77 percent (sample extremes reported).

### Observed temporal and cross-jurisdictional patterns
- Europe: slight downward trend in RWA density over time (transition to Basel II by 2007).
- United States: RWA density remained stable (reporting under Basel I).
- Possible drivers of declining RWA density:
  - Transition from Basel I to Basel II (migration to Advanced IRB).
  - Changes in business mix toward lower risk-weight assets.
  - Use of collateral reducing LGD.
  - Different points in the economic cycle affecting PD estimates.
- Caveat: public data are often limited and inconsistent.

### Breakdown of RWAs by risk type (sample averages and ranges)
- Credit risk represents 86 percent on average for the sample.
- Market risk and operational risk average 6.5 percent each for the sample.
- Range (maximum minus minimum) across business models and regions:
  - Credit risk: 38.4 percent.
  - Market risk: 36.7 percent.
- Market risk concentration: most banks have limited market risk; large global investment banks (mostly American and European) have average market risk of 17 percent.
- Operational risk: not disclosed by US banks (US banks do not yet report under Basel II as of data dates).

### Category-specific risk-weight observations (reported minimum - median - maximum ranges)
- Average (reported across samples):
  - Mortgages 6.4% - 16.2% - 40.6%
  - Corporates 31% - 55% - 95.2%
  - Institutions 5% - 17.5% - 30.5%
  - Other retail 10.3% - 35.7% - 89.3%
- Sample examples (selected):
  - Autonomous: Mortgages 5% - 20% - 53%; Corporates 32% - 59% - 76%
  - Barclays: Mortgages 7% - 15% - 49%; Corporates 33% - 55% - 89%
  - BBVA: Mortgages 8% - 15% - 23%; Corporates 37% - 52% - 78%; Other retail 4% - 16% - 27%; Institutions 14% - 33% - 48%
  - BNP: Mortgages 6% - 13% - 25%; Corporates 27% - 54% - 75%; Other retail 10% - 38% - 156%
  - KBW: Mortgages 6% - 18% - 53%; Corporates 26% - 55% - 158%; Institutions 6% - 19% - 34%; Other retail 7% - 36% - 64%
- Regional mortgage averages:
  - Asia average: 15 percent
  - Europe average: 14 percent
  - North America average: 40 percent
- Corporate loan averages:
  - Europe 50 percent
  - Asia 65 percent
  - North America 85 percent
- Unsecured loans: highest risk weights in North America (up to 100 percent).

### Drivers of RWA differences: external and bank internal parameters
- External parameters (selected):
  - Regulatory framework:
    - Banks follow Basel I or Basel II; within Basel II: Standardized Approach (SA), Foundation IRB (F-IRB), Advanced IRB (A-IRB).
    - Basel II introduced capital charges for operational risk; Basel I did not.
    - Jurisdictional implementation (24 jurisdictions observed): A-IRB used in 14 countries; F-IRB in 6 countries; Basel I in 2 countries; SA in 2 countries.
    - Reported average RWA densities by regulatory standard:
      - SA Average 62.9%
      - Basel I Average 62.7%
      - FIRB Average 44.2%
      - AIRB Average 38.8%
    - Floors:
      - Basel II initially set a floor decreasing from 95 percent to 80 percent in 2009.
      - European CRD floors reinstated until end-2011 with CRD4 draft proposing extension to 2015 with possible national waivers.
      - Dodd-Frank implementation created a permanent Basel I floor in the United States for minimum risk-based capital requirements.
  - Accounting framework:
    - IFRS versus US GAAP differences affect total assets (netting differences).
    - Distribution in 24 jurisdictions:
      - All IFRS Required: 17 countries
      - No IFRS: 4 countries
      - Some IFRS permitted: 3 countries
    - Density by accounting standard reported:
      - IFRS 39.6%
      - IFRS* (permitted) 34.6%
      - No IFRS 64.3%
  - Economic cycle and PD assumptions (point-in-time vs through-the-cycle) generate large variation in computed risk weights (example: with LGD 50 percent, PD = 6 bps → risk weight 44 percent; PD = 18 bps → risk weight 75 percent).
- Bank internal parameters (selected):
  - Business model and asset mix:
    - Bank grouping averages:
      - RB Average 57.1%
      - UB Average 44.3%
      - IB Average 29.6%
    - AIRB subset averages:
      - RB Average 45.0%
      - UB Average 40.1%
      - IB Average 18.3%
    - Investment banks historically had lower RWA densities due to trading books; Basel 2.5 and subsequent reforms could significantly raise market risk RWAs (BCBS QIS: trading-book market risk capital requirements will triple on average under Basel 2.5).
  - Portfolio characteristics:
    - LGD materially affects RW (RW linear relationship with LGD).
    - Longer average maturity increases RW.
    - Credit risk is the largest RWA component (86 percent on average).

### Evidence of subjectivity and survey findings
- Bank of England observation: risk buckets rose from around seven under Basel I to, conservatively, over 200,000 under Basel II; number of calculations rose from single figures to over 200 million.
- UK FSA Hypothetical Portfolio Exercise (HPE) results:
  - 13 UK banks; PD estimates compared to S&P historical default rates (1981-2008).
  - Large dispersion in estimated PDs — highest mean PD was 3 to 6 times larger than the lowest mean PD.
  - Biggest ranges on corporates; sovereign variations much smaller.
- Public disclosures often cite "model changes," "data cleansing," "RWA optimization," "parameter update" — possible signals of RWA reductions not reflecting improved risk.
- Cross-border comparisons limited unless banks share homogeneous business profiles.
- Some banks disclosed 2011 methodology changes that reduced RWAs without reflecting risk management improvements.

### Market risk: projected impacts of Basel 2.5 and Basel III (sample-based)
- Based on public data for a sample of 14 European banks and one Asian bank:
  - Average increase in RWAs for Basel 2.5 and III before mitigation: 36 percent.
  - Dispersion: maximum 104 percent, minimum 4 percent.
- BCBS QIS finding: trading-book market risk capital requirements will triple on average under Basel 2.5; some banks may face double-digit increases.
- Implementation timing:
  - Basel 2.5 (CRD3) implemented in Europe as of end-December 2011.
  - Basel 2.5 under consultation in the United States, with implementation expected later in 2012.

### Sample composition and aggregate deltas (Appendix II)
- Sample: 50 SIBs in 19 countries (North America 12, Europe 20, Asia-Pacific 18).
- Grouping by business model: investment banks 7, retail banks 12, universal banks 31.
- Aggregate total assets:
  - European banks exceed those of Asia Pacific by 136 percent.
  - European banks exceed those of North America by 149 percent.
- Aggregate RWAs:
  - European banks’ aggregate RWAs are higher than Asia Pacific banks by 71 percent.
  - European banks’ aggregate RWAs are higher than North American ones by 46 percent.
- Aggregate tangible common equity:
  - European banks’ tangible common equity is 69 percent higher than their Asia counterparts.
  - European banks’ tangible common equity is 38 percent up from their North American peers.
- Data sources: individual banks’ reports, Bloomberg, Bankscope, SNL, credit rating agencies; financial statements used "as is" with no adjustments.

### Notable anomalies: covered bonds (Box 2 highlights)
- Basel II/III treat covered bonds the same as bank unsecured debt for risk-weighting purposes, yet European RSA permits certain CRD-compliant covered bonds to receive risk-weights as low as 10%.
- Example LGD treatment: eligible covered bonds can have LGD between 11.25 percent and 12.5 percent applied, while Basel II LGD for senior unsecured bank debt is 45 percent.
- RSA risk weights for CRD compliant covered bonds by issuer rating:
  - AAA/AA: CRD compliant covered bond 10%
  - A: CRD compliant covered bond 20%
  - BBB: CRD compliant covered bond 20%
  - BB: CRD compliant covered bond 50%
  - B: CRD compliant covered bond 100%
- Concerns: preferential treatment encourages packaging of ABS into covered bonds; uneven treatment and jurisdictional divergence.
- Recommendation: require disclosure of covered bond exposures and whether preferential treatment was applied.

### Areas warranting attention and supervisory red flags
- RWA practices needing scrutiny:
  - Measurement of sovereign risk (forthcoming GFSR discussion noted).
  - Treatment of covered bonds (Box 2).
- Red flags prompting investigation:
  - Large swings in RWAs without material business-mix changes.
  - Strong Basel III risk-weighted capital ratio but weak leverage ratio.
  - Moving from more to less sophisticated approaches to exploit loopholes.
  - "Cherry picking" methodologies to optimize capital.
  - Decreasing RWAs as recession deepens for Basel II IRB reporters.
  - Significantly lower RWAs than peers without verifiable explanation.

### Policy options and reform directions (multipronged approach)
- Overarching objective: retain risk-based capital framework while diminishing scope for criticism and improving confidence via greater consistency and transparency.
- Recommended mix of measures:
  - Regulatory changes to the existing capital framework (floors, time-varying risk weights, scaling factors, targeted treatment of asset classes).
  - Enhanced supervision (Pillar II powers, discretionary exposure-specific floors, international surveys, supervisory peer reviews).
  - Increased market disclosure (more granular and frequent quarterly RWA composition by geography; disclosure of methodology changes; publication of benchmark portfolios).
  - Improved internal risk management (economic capital approaches, forward-looking metrics, tail-risk modeling).
- Specific reform options discussed:
  - Introduce or increase minimum floors (IRB formula floors, LGD topping-ups, avoid F-IRB uniform 2.5 year maturity catch-all).
  - Allow for time-varying or variable risk weights tied to macro-prudential policy and flow vs stock differentiation.
  - Allow variable scaling factor (adjust Basel II’s 1.06 scaling factor up or down).
  - Return to Basel II Standardized and abandon IRB (trade-offs: simplicity and transparency versus loss of incentives for improved risk management).
  - Suppress risk-based approach entirely and rely only on un-weighted leverage ratio (loss of risk differentiation vs objectivity).
  - Allow pure A-IRB with no floors (risk of excessive discretion; concerns over owner/manager incentives).
- Implementation considerations:
  - Gradual review and phased-in implementation to avoid cliff effects and allow coordination with other regulations.
  - Prolong existing floors to allow capacity-building for model implementation and validation.
  - International cooperation for G-SIBs; national/regional focus for domestic players.
  - Coordinate reforms with liquidity rules and macro-prudential frameworks; leverage ratio as an important backstop.

### Operational and cultural recommendations for banks
- Adopt economic (not purely regulatory) approaches to risk measurement and capital management.
- Enhance stress-testing, scenario-analysis, and simulation capabilities.
- Integrate risk metrics into business decision processes and capital allocation.
- Use risk-weighted and unweighted capital measures in tandem.
- Link capital ratios to macro-prudential policy and counter-cyclical buffers.

### Conclusion: synthesis and next steps
- Perceived differences in RWAs within and across countries have eroded trust in RWAs and capital ratios; without action, credibility of the regulatory framework could be affected.
- Paper is a first step to map extent and causes of RWA variability; it does not quantify variance decomposition.
- Many drivers of differences are justifiable; some are not. Full harmonization may be unachievable.
- Focus recommended on improving transparency, common guidance on methodologies, supervisory convergence, and a multipronged reform approach combining regulatory change, supervision, disclosure, and internal risk management.
- Retaining risk-sensitive capital ratios is important; use them alongside unweighted measures for robustness.

*Source: IMF staff working paper content (selected excerpts provided in the content unit).*

### 1. Overview of Key Concerns Resulting from Current RWAs Calculation Practices ...............7

### 1. Overview of Key Concerns Resulting from Current RWAs Calculation Practices

### Major themes and scope
- The content unit covers four main sections:
  - "1. Overview of Key Concerns Resulting from Current RWAs Calculation Practices" (page 7)
  - "2. Main Factors of Differences in RWA Densities across Jurisdictions and Banks" (page 13)
  - "3. Minimum, Median, and Maximum Risk-weights Attributed to Categories of Credit Risk" (page 21)
  - "4. Some Policy Options to Revisit the RWA Framework" (page 33)
- Supplementary content includes Figures 1–17, Boxes 1–2, and Appendices I–III.
- Time coverage and data references visible in the source listing include the period "1998–2011" and "1996–2010" in figure titles.

### Key findings and concerns (as organized in the source)
- The unit identifies "Key Concerns Resulting from Current RWAs Calculation Practices" (section title).
- It documents heterogeneity in RWA densities across jurisdictions and banks (section 2).
- It compiles minimum, median, and maximum risk-weights for categories of credit risk (section 3).
- It proposes and organizes "Some Policy Options to Revisit the RWA Framework" (section 4).

### Figures and empirical diagnostics included
- Figures provide comparative and diagnostic material, including:
  - Figure 1. "Capital Ratios Under Basel III Use Several Versions of the Basel Regime" (page 5)
  - Figure 2. "Comparison of Core Tier 1 over RWAs, Leverage Ratio and Core Tier 1 Equivalent" (page 9)
  - Figure 3. "Leverage Ratio and RWA Density for a Sample of 14 Global Banks with a 9 Percent Core Tier 1 Ratio (or equivalent)" (page 10)
  - Figure 4. "Ranges of CT1 and of RWA Density by Ratings and Distribution of Ratings for the 14 Banks with a 9 percent Core Tier 1 Ratio" (page 11)
  - Figure 5. "Evolution of RWA over Total Assets (1998–2011) across Regions" (page 11)
  - Figure 6. "Regulatory Frameworks in 25 Systemically Important Jurisdictions" (page 14)
  - Figure 7. "RWA Density by Regulatory Standards" (page 15)
  - Figure 8. "Acounting Standards in 25 Systemically Important Jurisdictions" (page 17)
  - Figure 9. "Default Rate by Region (1996–2010) and by Rating Agency" (page 18)
  - Figure 10. "RWA Densities for all Banks in our Sample Grouped by Region and by Business Model" (page 19)
  - Figure 11. "Breakdown of RWAs by Credit, Market and Operational Risks" (page 20)
  - Figure 12. "Minimum, Maximum, and Average Risk-Weights by Region for Different Categories of Credit Risk" (page 22)
  - Figure 13. "Basel 2.5 and Basel III Impact on RWAs" (page 23)
  - Figure 14. "Breakdown of Wholesale Assets" (page 24)
  - Figure 15. "Value at Risk for Market Risk under Basel II" (page 25)
  - Figures 16a and 16b. "Reforming RWAs Has to Rely on a Combination of Measures" (page 30)
  - Figure 17. "Possible Options to Reform the Existing RWA Framework" (page 32)

### Boxes and appendices included
- Box 1. "U.K. Financial Services Authority (FSA) Survey of RWA Practices" (page 25)
- Box 2. "Are There Some Anomalies in the Treatment of Covered Bonds?" (page 26)
- Appendices:
  - Appendix I. "Evolution of the Regulatory Capital Framework" (page 37)
  - Appendix II. "Methodology and Sample Description" (page 41)
  - Appendix III. "Standard and Poor’s (S&P) Risk-Adjusted Capital (RAC) Framework" (page 43)

### Analytical emphasis signalled by the contents
- Comparative analysis across regulatory regimes and accounting standards (Figures 6–8).
- Empirical measurement of RWA density variations and their drivers (Figures 3–5, 7, 10, 11, 12).
- Examination of historical default rates and risk correlations (Figure 9).
- Assessment of incremental regulatory reforms (Figure 13) and proposed reform options (Figures 16–17).
- Case or targeted evidence from supervisory surveys and specific instrument treatment (Boxes 1–2).

### Policy options and reform directions (section 4 and figures)
- The unit collects "Some Policy Options to Revisit the RWA Framework" and visually maps "Possible Options to Reform the Existing RWA Framework" (Figure 17).
- It frames reform as requiring a "Combination of Measures" (Figures 16a and 16b).

*Source: _wp1290 - 1. Overview of Key Concerns Resulting from Current RWAs Calculation Practices (IMF PDF), table of contents and list of figures/boxes/appendices as provided.*

### References .............................................................................................................

### _wp1290 - References

### Introduction and purpose
- Strengthening capital ratios is a key priority in the aftermath of the global financial crisis; emphasis has been on increasing the quantity, quality, and transparency of capital.
- Recent regulatory reforms have focused primarily on improving the numerator of capital ratios; changes to the denominator (risk-weighted assets, RWAs) have been more limited.
- Paper objectives:
  - Discuss the importance of RWAs in the regulatory capital framework.
  - Highlight main concerns and controversy surrounding RWA calculations.
  - Identify key drivers behind differences in RWA calculations across jurisdictions and business models.
  - Outline options to restore confidence in banks’ RWA numbers.
- Study scope excludes: a comprehensive analysis of the best way to measure risk or predict losses; determination of the optimal amount of capital per unit of risk; and a comparison of the respective merits of the leverage and risk-based capital ratios.

### RWAs in the regulatory framework
- RWAs are central to current regulatory solvency measures, which are defined in terms of RWAs; Basel III will introduce a leverage ratio defined as Tier 1 capital over total unweighted on-and off-balance sheet assets.
- Denominator heterogeneity:
  - Capital ratios under Basel III will use several versions of the Basel regime (Basel I, Basel II standardized/ foundation/IRB, Basel 2.5, Basel III).
- Functions of RWAs:
  - Provide a common measure for a bank’s risks.
  - Ensure capital allocated to assets is commensurate with risks.
  - Potentially highlight where destabilizing asset class bubbles are arising.

### Key concerns about RWAs (overview and potential market consequences)
- Concerns summarized include inadequate, inconsistent, non-transparent, and non-comparable capital measurement practices.
- Possible market consequences if RWAs are distrusted:
  - Market participants may re-calculate banks' capital ratios (most likely downwards) and disregard regulatory reported ratios.
  - Market participants could stop using risk-based capital ratios and turn to the leverage ratio.
  - Investors may require higher capital ratios to compensate for perceived understatement of RWAs.
  - Investors could restrict lending to banks for which they have doubts about reported capital adequacy.
- Table 1 summarized concerns and impacts across regulators, banks, and investors (see source).

### Comparability of capital ratios: evidence and key statistics
- Sample used: 50 systemically important banks (SIBs) across three regions: Asia Pacific (“Asia”), Europe (“EU”), and North America (“NA”).
- Observed differences in capital metrics:
  - Core Tier 1 (CT1) over RWAs, Tangible Common Equity (TCE) over tangible Total Assets (TA), and TCE over RWAs show higher capital levels in Asia Pacific and North America with wider dispersion among European banks.
  - A sub-sample of 14 banks reporting a 9 percent Core Tier 1 ratio:
    - Leverage Ratio varied between 3 percent (Europe and Asia Pacific) and 7 percent (North America).
    - RWA density (RWAs as percent of TAs) varied from 23 percent (lowest by region example) to 77 percent (highest by region example).
  - For AA rated banks in the broader 50-bank sample, reported CT1 ranges between 9 percent and 21 percent.
- Region/business-model patterns:
  - RWA density by region averages cited in figures:
    - Global Average CT1 to RWAs: 11.0%
    - TCE/TA Global Average: 4.9%; EU 3.5%; NA 5.9%; AP 5.8%
    - Core Tier 1 Equivalent (TCE/RWA) Global Average: 11.0%; EU 10.6%; NA 10.5%; AP 11.9%
  - RWA density trends (1998–2011):
    - North America average RWA/TA reported as 57%
    - Europe average as 35%
    - Asia average as 51%

### Observed temporal and cross-jurisdictional RWA patterns
- RWA density has exhibited a slight downward trend over time in Europe (transition to Basel II by 2007) but remained stable in the United States (reporting under Basel I).
- Possible drivers of declining RWA density:
  - Transition from Basel I to Basel II (especially migration to Advanced IRB) enabling lower RWAs.
  - Changes in business mix toward assets with lower risk-weights.
  - Use of collateral which decreases LGD.
  - Different points in the economic cycle affecting PD estimates.
- Caution: publicly available data are often limited and inconsistent, making some explanations hard to prove.

### Key drivers of differences in RWA calculations
- Factors split into External Parameters and Bank Internal Parameters.

- External Parameters (selected):
  - Regulatory framework:
    - Banks follow Basel I or Basel II; within Basel II: Standardized Approach (SA), Foundation IRB (F-IRB), Advanced IRB (A-IRB).
    - Basel II introduced capital charges for operational risk; Basel I did not.
    - Regulatory incentives influence asset selection and reported RWA density.
    - Observed classification across 24 jurisdictions: A-IRB used in 14 countries; F-IRB in 6 countries; Basel I in 2 countries; SA in 2 countries.
    - Reported average RWA densities by regulatory standard (from figures/text):
      - SA Average 62.9%
      - Basel I Average 62.7%
      - FIRB Average 44.2%
      - AIRB Average 38.8%
    - Floors:
      - Basel II initially set a floor decreasing from 95 percent to 80 percent in 2009 (then expected removal); crisis effects extended floors.
      - European CRD floors reinstated until end-2011 with CRD4 draft proposing extension to 2015 with possible national waivers.
      - Dodd-Frank implementation created a permanent Basel I floor in the United States for minimum risk-based capital requirements.
  - Accounting framework:
    - Use of IFRS versus US GAAP (or national GAAP) affects total assets (netting differences, derivatives netting under US GAAP but disallowed under IFRS).
    - Distribution in 24 jurisdictions:
      - All IFRS Required: 17 countries
      - No IFRS: 4 countries
      - Some IFRS permitted: 3 countries
    - Density by accounting standard reported: IFRS 39.6%; IFRS* (permitted) 34.6%; No IFRS 64.3% (as shown in figure).
  - Economic cycle and PD assumptions:
    - PD estimations' treatment (“point-in-time” vs “through-the-cycle”), historical data differences, rating agency differences, and time periods used can produce large variation in computed risk weights.
    - Example: Barclays (April 2011) illustration: with LGD 50 percent, PD = 6 bps → risk weight 44 percent; PD = 18 bps → risk weight 75 percent.

- Bank Internal Parameters (selected):
  - Business model and asset mix:
    - Banks classified broadly as retail/commercial banks (RB), universal banks (UB), or investment banks (IB).
    - Observed average density by business model:
      - RB Average 57.1%
      - UB Average 44.3%
      - IB Average 29.6%
    - Under Basel II AIRB subset averages: RB Average 45.0%; UB Average 40.1%; IB Average 18.3%
    - Retail banks tend to have higher RWA densities than universal and investment banks.
    - Investment banks historically had lower RWA densities due to trading books; Basel 2.5 and subsequent reforms (including CVA) are expected to increase market risk RWAs—Basel Committee studies indicate market risk could triple on average, with some banks experiencing over 10 times higher risk weights post Basel 2.5.
  - Portfolio characteristics:
    - LGD (collateral quality/quantity) significantly impacts risk weights (RW linear relationship with LGD).
    - Longer average maturity increases RW.
    - Credit risk is the largest RWA component: 86 percent on average for the sample.
    - Market risk and operational risk average 6.5 percent each for the sample.

### Implications and framing for policy debate
- The paper starts from the preference to retain risk-based capital ratios, and aims to:
  - Map out concerns and differences in RWA calculation and reporting.
  - Suggest policy options to strengthen the RWA framework and improve market confidence.
- Identified policy-relevant points include:
  - The coexistence of multiple regulatory regimes and accounting standards complicates cross-bank comparability.
  - Supervisory practices, model validation, model approvals, and the use of Pillar 2 buffers vary across jurisdictions and significantly influence reported RWAs.
  - Floors and harmonized supervisory practices can mitigate some divergences, but cannot fully eliminate them.
  - Market participants may shift emphasis to unweighted metrics (leverage) or demand higher risk-weighted capital if confidence in RWAs is not restored.

*Italic source attribution: IMF staff working paper content (selected excerpts provided in the content unit).*

### 7.5 percent respectively, but they are spread differently. US banks, who do not yet report

### _wp1290 - 7.5 percent respectively, but they are spread differently. US banks, who do not yet report

### Breakdown of RWAs by Risk Type
- Source: SNL, individual bank reports, and Staff estimates for June 2011.
- Operational risk is not disclosed by US banks (US banks do not yet report under Basel II).
- Market risk is limited for most banks but concentrated in large global investment banks (and a few universal banks), mostly American and European, whose average market risk is 17 percent.
- Range between maximum and minimum:
  - Credit risk: 38.4 percent across all business models and regions.
  - Market risk: 36.7 percent.

### Credit risk: variations and drivers
- The A-IRB formula is complex and allows wide interpretation; key inputs include Probability of Default (PD), Loss Given Default (LGD), Exposure at Default (EAD) and Maturity (M).
- Bank of England observation: number of risk buckets increased from around seven under Basel I to, on a conservative estimate, over 200,000 under Basel II; number of calculations rose from single figures to over 200 million.
- Criticisms focus on Basel II IRB, particularly Advanced IRB (A-IRB), where banks have the most flexibility.
- Divergences in implementation by domestic supervisors drive variation: risk parameter floors, treatment of non-performing loans, parameters for cycle adjustment, and migration matrices.
- Variations in RWAs across banks due to credit risk are described as "quite large."

### Regional and category risk-weight comparisons (based on Pillar 3 and analyst reports)
- Table and sample sources: analyst reports, Pillar 3 disclosure, company data and analysts’ estimates for various bank samples (Autonomous, Barclays, BBVA, BNP, KBW, Average).
- Reported ranges by sample and credit category (Minimum - Median - Maximum risk weights):
  - Average (reported): Mortgages 6.4% - 16.2% - 40.6%; Corporates 31% - 55% - 95.2%; Institutions 5% - 17.5% - 30.5%; Other retail 10.3% - 35.7% - 89.3%.
  - Examples from other samples include:
    - Autonomous: Mortgages 5% - 20% - 53%; Corporates 32% - 59% - 76%.
    - Barclays: Mortgages 7% - 15% - 49%; Corporates 33% - 55% - 89%.
    - BBVA: Mortgages 8% - 15% - 23%; Corporates 37% - 52% - 78%; Other retail 4% - 16% - 27%; Institutions 14% - 33% - 48%.
    - BNP: Mortgages 6% - 13% - 25%; Corporates 27% - 54% - 75%; Other retail 10% - 38% - 156%.
    - KBW: Mortgages 6% - 18% - 53%; Corporates 26% - 55% - 158%; Institutions 6% - 19% - 34%; Other retail 7% - 36% - 64%.
- Regional observations:
  - North American banks have, on average, higher risk weights in most credit risk categories (except loans to banks), largely because many US banks still operate under Basel I (risk-weights: 0 percent for OECD Sovereigns, 20 percent for OECD banks, 50 percent for mortgages, and 100 percent for corporates).
  - Mortgages: Asia average 15 percent; Europe average 14 percent; North America average 40 percent.
  - Europe mortgage RWA range: 7 percent to 27 percent.
  - Within North America, Canada and the United States diverge: US banks push the maximum towards 50 percent, Canadian banks drive the minimum below 10 percent (some government guaranteed portfolios).
  - Global banks often use a combination of Basel II SA, F-IRB, A-IRB, and sometimes Basel I, depending on loan location.

### Category-specific notes
- Corporate loans: averages — Europe 50 percent, Asia 65 percent, North America 85 percent.
- Unsecured loans: highest risk weights in North America (up to 100 percent); smallest range in Asia.
- Exposures to credit cards vary greatly from bank to bank.
- Loans to banks: relatively similar average risk weights across regions with moderate dispersion.

### Market risk: Basel 2.5 and Basel III impact
- BCBS QIS finding: trading-book market risk capital requirements will triple on average under Basel 2.5, with some banks experiencing double-digit increases.
- Based on public data for a sample of 14 European banks and one Asian bank, the average increase in RWAs for Basel 2.5 and III before mitigation is 36 percent.
  - Dispersion: maximum 104 percent, minimum 4 percent.
- Final RWA impact is expected to be lower as banks implement mitigating actions.
- Figure source: Individual banks’ reports, staff estimates; December 2010.
- Implementation timing and differences:
  - Basel 2.5 (CRD3) implemented in Europe as of end-December 2011.
  - Basel 2.5 still under consultation in the United States, with implementation expected later in 2012.
- Factors causing RWA differences across regions:
  - Differences in regulatory intensity of supervisory model approval.
  - Definitional differences (e.g., scope of securitizations).
  - Imposition of surcharges (example: correlation trading portfolio surcharge — US proposal: 15 percent of standard charges to CRM; Europe: 8 percent of standard charges floor).
  - Use of external ratings: Europe allows standard specific risk charge to be a function of external rating for covered debt and securitization positions; United States proposing alternatives to external ratings (Dodd Frank Act, section 939A).

### Business model effects and incentives
- Banks biased towards credit trading products will attract higher risk weights (due to the Incremental Risk Charge) than banks focused on flow forex, rates, equities, or advisory.
- Banks with a higher proportion of secured financing will carry lower risk weights than banks heavily exposed to securitizations or principal/proprietary trading.
- OTC derivatives will see a steep rise in overall risk weights, incentivizing moves to CCPs or secured OTC transactions.

### RWA calculation subjectivity and evidence from surveys
- A mix of institutional, accounting, regulatory and bank-specific factors influence risk modeling choices.
- UK FSA Hypothetical Portfolio Exercise (HPE) (2007 and 2009):
  - Submitted to 13 UK banks; covered 50 sovereign issuers, 100 banks, and 200 large companies.
  - Compared participants’ internal PD estimates against historical annual default rates used by S&P (1981-2008).
  - FSA constructed a "jointly-rated sample" for cross-bank comparisons.
  - HPE results: large dispersion in estimated PDs — highest mean PD was 3 to 6 times larger than the lowest mean PD.
  - Biggest ranges observed on corporates; banks to a lesser extent; variations on sovereigns were much smaller.
- Public disclosures often refer to "model changes," "data cleansing," "RWA optimization," "parameter update" — which could indicate RWA reductions not tied to actual risk improvement.
- Cross-border comparisons are of limited value unless banks share homogeneous business profiles.
- Disclosure granularity and quality are variable; it is nearly impossible, from public data alone, to determine whether RWA variations reflect genuine asset mix/risk appetite differences or shifts in risk measurement.
- Some banks publicly disclosed 2011 methodology changes that reduced RWAs without reflecting improvements in risk management or overall strength.

### Areas warranting particular attention
- RWA practices criticized notably in:
  - Measurement of sovereign risk (forthcoming Global Financial Stability Report will discuss sovereign risk).
  - Treatment of covered bonds (key concerns summarized in Box 2 of the source).
- Basel Committee reviewing RWA methodology; senior BIS officials called for review of sovereign risk (Hannoun, 2011).

*Source: Individual bank reports (Pillar 3 disclosure), Bankscope, SNL, staff estimates; June 2011 and December 2010 data as presented in the source text.*

### Box 2. Are There Some Anomalies in the Treatment of Covered Bonds?

### Box 2. Are There Some Anomalies in the Treatment of Covered Bonds?

### Anomaly in regulatory treatment of covered bonds
- Basel II/III treat covered bonds the same as bank unsecured debt for risk-weighting purposes (see first line of table 1).
- For European banks using the revised standardized approach (RSA), certain “Capital Requirement Directive (CRD)-compliant” covered bonds issued by European Union (EU) banks can be assigned a risk-weight as low as 10 percent.
- The bonds must meet the requirements of Article 52(4) of Directive 85/611/EEC (UCITS 52(4)), and be secured by eligible assets prescribed under the European CRD.
- Example of loss-given-default (LGD) treatment:
  - An LGD comprised between 11.25 percent and 12.5 percent can be applied to eligible covered bonds (meeting certain criteria).
  - Under Basel II, the LGD is 45 percent, similar to senior unsecured bank debt.
- The preferential treatment of covered bonds is a European specificity and is to be extended until 2013 or 2014.

### Implications and mechanics across approaches
- Standardized versus IRB approach differences:
  - Under the standardized approach (RSA), weights depend on the credit rating of the issuing institution.
  - Under the IRB approach, risk-weights (RWs) for covered bonds are derived from the probability of default of the issuer or sponsor bank (linked to its senior unsecured rating).
  - The table below assumes the jurisdiction has mandated the use of the credit assessment-based method (“Option 2”) where the risk weight of an issuer’s senior unsecured debt depends on the issuer’s external credit rating.
  - The central government risk weight-based method (“Option 1”) bases the risk weight of an issuer’s senior unsecured debt on the external credit rating of the central government of the jurisdiction in which the issuer is incorporated.

- Basel II RSA Risk Weights for Senior Unsecured Debt and Covered Bonds (by originating institution’s credit rating):
  - AAA/AA:
    - Senior unsecured debt and non-CRD compliant covered bond: 20%
    - CRD compliant covered bond: 10%
  - A:
    - Senior unsecured debt and non-CRD compliant covered bond: 50%
    - CRD compliant covered bond: 20%
  - BBB:
    - Senior unsecured debt and non-CRD compliant covered bond: 50%
    - CRD compliant covered bond: 20%
  - BB:
    - Senior unsecured debt and non-CRD compliant covered bond: 100%
    - CRD compliant covered bond: 50%
  - B:
    - Senior unsecured debt and non-CRD compliant covered bond: 150%
    - CRD compliant covered bond: 100%

### Concerns and behavioral incentives
- Key concerns:
  - Lack of differentiation in LGD and risk-weighting between covered bonds backed by risky assets (e.g., shipping, commercial property) and those backed by stable higher quality assets (e.g., prime residential mortgages and public sector collateral).
  - Uneven treatment of covered bonds and securitizations, with covered bonds benefiting from a much more favorable treatment, encouraging banks to package ABS assets into covered bonds.
  - Link between covered bond risk weights and sovereign ratings, allowing covered bonds backed by bank bonds to continue to receive a preferential risk-weight even in the event of a downgrade of the banks, if the sovereign rating of the country of issue remains above a certain threshold.
- Jurisdictional divergence:
  - Not all European countries follow CRD rules; some have adopted a stricter framework, increasing differences in RW approaches across jurisdictions.
  - Recommendation: until a full review of covered bonds RW practices is conducted, banks should be required to disclose their covered bond exposures and to indicate whether they have benefited from any preferential treatment under CRD provisions.

### Red flags for risk measurement and RWA calculation
- Regulators should investigate practices when banks:
  - Experience large swings of RWAs over time, even when there has been no material change in their business mix.
  - Report a strong Basel III risk-weighted capital ratio, but have a weak leverage ratio (based on what banks may disclose during the observation period).
  - Move from a more sophisticated approach (e.g., A-IRB) to a less sophisticated one to benefit from some “loopholes” (e.g., a uniform 2.5 year maturity under F-IRB or a zero risk-weight on sovereign risk under the Standardized approach).
  - “Cherry pick” the most favorable methodology for each type of exposure and combine several methodologies with a clear view to optimize capital, and not as a result of the coexistence of various operating environments in different jurisdictions.
  - Report decreasing RWAs as the recession deepens (if they report under Basel II IRB).
  - Report much lower RWAs than peers (i) in the same jurisdiction or (ii) peers with the same business model, suggesting that banks support comparable/identical risks with very different levels of capital.
  - Cannot provide a verifiable and justifiable explanation for reporting significantly lower risk weights and refer to them as “methodology changes.”

### What can be done to restore confidence in RWAs — objectives and principles
- Objectives of RWA reforms:
  - Retain the risk-based capital framework while diminishing the scope for criticism and improving confidence.
  - Ensure a greater level of consistency in methodologies and higher transparency in the outputs, without seeking full harmonization that would eliminate legitimate differences across business models and jurisdictions.
  - Encourage banks to develop RWA methodologies that capture genuine risks rather than to “optimize” RWAs to comply with “the letter, rather than the spirit” of regulations.
- Timing and transition considerations:
  - A gradual review may be necessary to conduct an impact study, avoid cliff effects, and allow time for coordination with other regulations.
  - A phased-in implementation of a stricter framework for risk-weighting sovereigns may be necessary to avoid precipitating further withdrawal of banks from sovereign bonds.
  - The existing floor should be prolonged for a longer period to allow banks and supervisors time to build in sufficient capacity to implement and validate internal models.
  - Basel III leverage ratio will be implemented in 2018; Basel I floors could help transition to the new regime.

### Design features for reforms
- Reforms should:
  - Balance creating a more level playing field through improved harmonization, transparency, comparability across banks and jurisdictions, and allowing flexibility at bank or country level to better calibrate RWAs.
  - Be decided and implemented at the right level: high degree of international cooperation desirable for G-SIBs; more national or regional focus may be appropriate for purely domestic players.
  - Focus first on the most visible deficiencies, with credit risk (sovereign risk in particular) as a likely area for reform.
  - Be assessed against capital ratios at large: reform aims to improve risk measurement and recognition, not to address intrinsic increases in asset riskiness.
  - Be coordinated with the broader regulatory agenda, avoiding piecemeal approaches and ensuring consistency with liquidity rules and macro-prudential rules.
  - Make risk weights more dynamic to dampen asset bubbles and foster weak credit growth; interact closely with the counter-cyclical buffer.

### Policy options and a multipronged approach
- Recommended mix of measures:
  - Regulatory changes to the existing capital framework.
  - More intrusive supervisory intervention.
  - Additional disclosure by banks to foster greater market discipline.
  - More robust risk management and strategy within banks.
- Suggested initial actions:
  - Run an international survey on a sample of cross-border SIBs to compare G-SIBs’ RWA practices; the Basel Committee could lead a peer review using a “hypothetical portfolio” to assess risk-weighting across banks.
  - Enhanced supervision using Pillar II powers; increase supervisory resources where needed.
  - Strengthen disclosure: provide more granular information on a frequent basis to foster market discipline while fuller studies and policy responses are developed.
- Views on authority to measure RWAs:
  - Spectrum ranges from banks and CRAs being best placed to measure risks to regulators determining floors for each asset regardless of banks’ internal assessments.
  - Workable solutions likely fall between full bank modeling and prescriptive regulatory floors: allow banks to use internal models while regulators and supervisors address deficiencies and contain excessive discretion under clear guidelines.

### Operational and cultural changes within banks
- Banks should:
  - Rely more on an economic rather than purely regulatory approach for measuring and managing risk.
  - Enhance stress-testing, scenario-analysis, and simulation capabilities to understand how risk profiles might change and to develop action plans for mitigating certain risks and optimizing capital allocation.
  - Integrate risk metrics into key business processes and use them to influence critical business decisions.
- Capital adequacy assessment:
  - Use risk-weighted based measures in tandem with capital measures relative to total assets to capture the riskiness of exposures while limiting excessive leverage.
  - Recognize the Basel III leverage ratio as an important backstop to risk-based ratios that rely extensively on banks' models.
  - Link capital ratios to the macro-prudential framework to address exuberant or constrained asset classes.

*Source: Box 2 from _wp1290 - Box 2. Are There Some Anomalies in the Treatment of Covered Bonds?_*

### Introduction  of  floors  &

### _wp1290 - Introduction  of  floors  &

### Policy options to revisit the RWA framework
- Reforming regulations: introduce or increase minimum floors
  - Floors can be introduced at different levels, within the IRB formula, on RWAs or on capital ratios, and their effectiveness will depend on the objectives.
  - Increasing floors on the IRB approach could reduce its attractiveness (in terms of lower RW and lower capital requirements) versus the Standardized Approach, and encourage banks to be more prudent and conservative.
  - On PD, encourage banks to use “through the cycle” measures, versus “point in time” PDs, and ensure that crisis periods and fat tail risks are properly accounted for.
  - On LGD, some countries may consider topping-up the 10 percent LGD floor enshrined in Basel II based on their experience
  - On M, avoid the catch-all 2.5 year average maturity under F-IRB, as it may not reflect the long duration of the mortgage books of most retail banks
  - On RW, introduce minimum floors (including temporary ones) on asset classes experiencing excessive growth, or on assets deemed riskier (re-securitization, market risk, “high volatility CRE”, etc...).
  - On Capital Ratios, provide a safeguard against an excessive decline in minimum capital requirements. The Basel II floor on the amount of capital required (80% of the capital that would be required under Basel I) could be prolonged for a longer period.
  - Conversely, regulators may also continue to give preferential treatment to encourage certain types of lending (lower risk-weights for loans to SMEs).

- Allow for time-varying or variable risk weights
  - In conjunction with macro-prudential policies, risk weights should go up and down to limit or foster excessive or insufficient growth on certain assets at certain points in the cycle.
  - Risk-weights could be used to target emerging risks in specific exposure classes, and could be different for the flow relative to the stock to directly influence lending.
  - For IRB banks, a multiplicative scalar for the sector under consideration could be applied to internal model outputs.

- Allow for a variable scaling factor
  - Risk-weights would stay constant, but Basel II’s 1.06 scaling factor could be adjusted upwards or downwards to divert or attract capital to certain asset classes.

- Return to Basel II Standardized and abandon the IRB approach
  - Advantages:
    - Simple approach, more transparent, easy to monitor
    - Still allows for some risk-sensitivity (more than Basel I)
  - Disadvantages:
    - Goes against efforts to promote IRB systems and to allow sophisticated banks to move away from cruder methodologies
    - Increases reliance on CRA when those are under intense scrutiny
    - Differentiation is too limited in some asset classes (e.g. all mortgages are equally weighted)
    - Removes the incentive for banks to develop good risk management and to get exposures to assets carrying a penalizing RW, even though they are properly priced and entail social benefits
    - Is more expensive (increases capital requirements), in particular on corporate and mortgage exposures

- Suppress completely the risk-based approach and rely only on the un-weighted leverage ratio
  - A leverage ratio is viewed as (i) being simple to compute and more objective; (ii) offering a safeguard against model risk and measurement errors; (iii) reducing risks of banks attempting to “game” the system, and (iv) putting a cap on the over-accumulation of “low or zero risk” assets.
  - The argument for adjusting for asset risk is that the pool of assets of each individual bank may differ greatly. Risk-based capital allows to (i) differentiate between risky and safer assets; (ii) optimize the level of capital.

- Allow banks to rely purely on A-IRB and remove floor constraints
  - In theory, this extreme outcome would allow all banks to rely on their own internal models, unfettered by floors or caps, to encourage them to develop the most efficient models.
  - In practice, many contend that shareholders and bank managers do not have adequate incentives to ensure the sufficiency of risk weights, so unlimited discretion may prove unwarranted.

### Enhancing supervision
- Greater use of Pillar II at individual banks or at system-wide level
  - Supervisors can rely on the broad powers conferred by Pillar II to correct RW at any particular institution (based on its business model, or on an excessive deviation from peers’ best practices, or as an add-on buffer to mitigate modeling risk).

- Discretional power to raise floors on specific exposures
  - Supervisors should be able to build-in additional buffers, by requiring higher risk-weights (and more capital) on assets they deem riskier.

- Increased monitoring and remedial powers
  - Supervisors need to assess on an ongoing basis (not just in the pre-validation phase) the robustness of banks’ models and suggest remedial actions if necessary.

- Harmonize implementation of existing rules
  - Supervisors need to ensure the existence of a rigorous risk-weighting process, based on appropriate, and transparent standards.
  - Need for more international harmonization of supervisory practices.

- Conduct an international survey of G-SIBs’ RWA practices
  - The Basel Committee could conduct a survey based on test portfolios to compare standards of implementation and banks’ methodologies across jurisdictions.

- Supervisory peer review and cross-country monitoring
  - Use validation teams working to verify the methodologies used at individual (international) banks and ensure their compliance with international standards.
  - Work could be conducted:
    - At the international level, possibly under the auspices of the Basel Committee. Horizontal reviews of individual institutions would help assess the level of variation across supervisory practices and help develop a more consistent implementation of Basel rules across jurisdictions.
    - Alternatively, national supervisors could participate in joint examinations of individual banks.

### Fostering greater market discipline
- Greater market disclosure to improve confidence
  - Banks should disclose more granular and frequent (quarterly) information on the composition of their RWAs, ideally broken down by geography.
  - They should also explain the methodology applied to RWA and to capital in general, and detail any material changes.
  - Basel I floors should be disclosed in addition to Basel II requirements.

- Publication of a benchmark portfolio
  - Based on an international benchmark and theoretical portfolio, G-SIBs could publish on a regular basis their methodology to measure risks.

- Improved communication
  - Better dialogue could take place between banks and investors, and the analyst community at large, particularly on changes in models, exemptions, or material reduction in RWA levels.

- Enhanced role for bank auditors
  - Auditors could expand reports on risk-taking, risk appetite and risk management, in a qualitative and quantitative way.

### Improving banks’ internal risk management
- Adopt a more “economic” approach for measuring capital and managing risk
  - Would help integrate more closely business decisions with cost of risk and of capital;
  - More dynamic measurement of risks than provided by ratios;
  - Would be more efficient than a purely regulatory approach for RWA calculation, capital allocation and asset pricing.

- Develop more forward-looking risk measurement metrics
  - Banks would benefit from building up more dynamic models that reflect changes in their risk profile and portfolios and allow them to adapt to new conditions.

- Develop models that better capture tail risk
  - Banks need to factor in extreme stress scenarios and have contingency plans to deal with them.

- Abandon IRB and move back to Standardized
  - Sophisticated banks already reporting under IRB may voluntarily revert back to the more basic Standardized approach to show investors their commitment to transparency, simplicity and objectivity. The likely increase in capital requirements could be offset by improved investor confidence.

### Conclusion — key findings and recommendations
- Perceived differences in RWAs within and across countries have led to a diminishing of trust in the reliability of RWAs and capital ratios, and if not addressed, could affect the credibility of the regulatory framework in general.
- The paper is a first step towards shedding light on the extent and causes of RWA variability and to foster policy debate.
- The paper seeks to disentangle key factors behind observed differences in RWAs, but does not quantify how much of the RWA variance can be explained by each factor.
- It concludes that a host of factors drive differences in RWA outputs between firms within a region and across regions; many of these factors can be justified, but some less so.
- Differences in RWAs are not only the result of banks’ business model, risk profile, and RWA methodology (good or bad), but also the result of different supervisory practices.
- Aiming for full harmonization and convergence of RWA practices may not be achievable; some differences are expected to remain.
- It may be more constructive to focus on improving the transparency and understanding of outputs, and on providing common guidance on methodologies, for banks and supervisors alike.
- The paper identifies a range of policy options and contends that a multipronged approach seems the most effective path of reform:
  - A combination of regulatory changes to the RWA regime, enhanced supervision, increased market disclosure, and more robust internal risk management may help restore confidence in RWAs and safeguard the integrity of the capital framework.
- Even if RWAs are not perfect, retaining risk-sensitive capital ratios is still very important, and these can be backstopped by using them in tandem with unweighted capital measures.
- The paper aims to encourage discussion and policy suggestions, while the Basel Committee undertakes a more extensive review of the RWA framework.

### Appendix I — evolution of the regulatory capital framework (highlights)
- Basel I (introduced in 1988)
  - Capital framework originally dealt with credit risk; market risk was added later.
  - Assets were assigned risk weights: 0, 10, 20, 50 and 100 percent for major buckets.
  - Four categories of assets: claims on sovereigns, banks, residential mortgage loans, and corporates.

- Basel II (2004–2009)
  - Revised the way RWAs are computed and broadened risks covered to include credit risk, market risk, and operational risk.
  - Assigns risk weights based on external CRA ratings or internal ratings calculated by banks.
  - Offered three approaches for credit risk: Standardized, Foundation IRB (F-IRB), and Advanced IRB (A-IRB).
  - Built-in safeguards: a scaling factor of 1.06 to be applied to RWA calculated under IRB, and the use of capital floors based on Basel I.

- Basel 2.5 and Basel III
  - Basel 2.5 introduced incremental risk charge (IRC), stressed VaR capital charge, and credit valuation adjustment (CVA) charge.
  - Basel III improves and harmonizes the numerator of risk-based capital ratios, increases minimum capital requirements to 7 percent (including the capital conservation buffer), creates a capital countercyclical buffer (variable, of up to 250 basis points), and introduces an international leverage ratio requirement.
  - Systemically important banks (SIBs) will be subject to an additional capital requirement of 1 percent to 2.5 percent of RWAs.
  - A full-fledged review of risk-weighted assets had not started yet (as of the document).

- Credit risk calculation choices
  - Under Basel I: five buckets 0, 10, 20, 50, 100 percent.
  - Under Basel II SA: CRA ratings can drive higher or lower risk weights (examples provided: sovereigns up to 150 percent; residential mortgage reductions to 35 percent; consumer retail lending to 75 percent).
  - Standardized simplified version for jurisdictions with low CRA penetration: general 100 percent risk weight for unrated corporates and 75 percent for retail exposures.

- IRB approach
  - Foundation IRB: banks calculate PD; regulators provide formulas to convert PD, LGD, EAD into risk weights.
  - Advanced IRB: banks calculate PD, LGD, and EAD.
  - IRB intended to provide strong capital incentive for banks with good risk management; expected to lower RW for less-risky assets and raise them for lower quality assets.
  - Market and operational risk frameworks were further enhanced (Basel 2.5, Basel III). Operational risk approaches include Basic Indicator Approach (BIA), Standardized Approach (TSA), and internal measurement approach / advanced measurement approach (AMA).

*Source: _wp1290 - Introduction  of  floors  & (PDF chapter/section).*

### APPENDIX II. METHODOLOGY AND SAMPLE DESCRIPTION

### APPENDIX II. METHODOLOGY AND SAMPLE DESCRIPTION

### Sample composition and grouping
- Sample size: 50 systemically important banks (SIBs) in 19 countries, spanning Europe, North America and Asia-Pacific.
- Groupings:
  - By region: North America 12, Europe 20, Asia-Pacific 18.
  - By business model: investment banks 7, retail banks 12, universal banks 31.
  - By regulatory reporting and accounting standards prevalent in home jurisdictions.
- Ratings: Ratings tend to be concentrated in the single A and higher categories.

### Data sources and accounting treatment
- All information comes from publicly available sources.
- Data sources include: individual banks’ reports (no adjustments to financial statements), Bloomberg, Bankscope and SNL, and the three main credit rating agencies.
- Aggregate and bank-level figures are based on these sources and staff estimates.

### Aggregate comparisons by region (exact reported deltas)
- Aggregate total assets:
  - European banks exceed those of Asia Pacific by 136 percent.
  - European banks exceed those of North America by 149 percent.
- Aggregate Risk-Weighted Assets (RWAs):
  - European banks’ aggregate RWAs are higher than Asia Pacific banks by 71 percent.
  - European banks’ aggregate RWAs are higher than North American ones by 46 percent.
- Aggregate tangible common equity:
  - European banks’ tangible common equity is 69 percent higher than their Asia counterparts.
  - European banks’ tangible common equity is 38 percent up from their North American peers.
- Note: The deviation in European total assets appears much wider than in risk-weighted assets or tangible common equity.

### Sampled banks (by region and country)
- Asia Pacific
  - AUSTRALIA: ANZ Banking Group; Commonwealth Bank of Australia; Macquarie Group; National Australia Bank; Westpac Banking Corp
  - CHINA: Bank of China
  - HONG KONG: Bank of East Asia; Hang Seng Bank (part of HSBC)
  - INDIA: ICICI Bank; State Bank of India
  - JAPAN: Mitsubishi UFJ FG; Mizuho FG; Nomura Holdings Inc; Sumitomo Mitsui FG
  - SINGAPORE: DBS Group Holdings; United Overseas Bank
  - SOUTH KOREA: Kookmin Bank; Woori Bank
- Europe
  - UNITED KINGDOM: Barclays; HSBC Holdings; Lloyds Banking Group; Royal Bank of Scotland
  - FRANCE: BNP Paribas; Crédit Agricole; Groupe BPCE; Société Générale
  - GERMANY: Commerzbank; Deutsche Bank
  - ITALY: Intesa Sanpaolo; UniCredit
  - SPAIN: Banco Bilbao Vizcaya Argentaria; Banco Santander
  - DENMARK: Danske Bank
  - NETHERLANDS: ING Bank
  - NORWAY: DnB NOR
  - SWEDEN: Nordea; Skandinaviska Enskilda Banken
  - SWITZERLAND: Credit Suisse Group; UBS
- North America
  - CANADA: Bank of Montreal; Bank of Nova Scotia; Royal Bank of Canada
  - UNITED STATES: Bank of America; Citigroup; Goldman Sachs; JPMorgan Chase; Morgan Stanley; PNC Financial Services; SunTrust Banks; US Bancorp; Wells Fargo

### Methodological notes on S&P’s RAC framework (from adjacent Appendix III content included in the source)
- Development and comparability:
  - S&P developed the “RAC” ratio in 2009 to facilitate comparability and transparency of banks’ capital adequacy globally.
  - After diversification, the RAC ratio is broadly comparable to Core Tier 1 (and to the upcoming Common Equity Tier 1 under Basel III), with some country variations.
- Numerator adjustments:
  - RAC adjusts the numerator by excluding hybrid instruments and applying stricter deductions from capital for pension deficits, broadly in line with the upcoming Basel III definition of capital.
- Denominator and risk adjustments:
  - The methodology for calculating the denominator differs more significantly from Basel.
  - RAC adjusts for concentration and diversification of credit, market, operational and insurance risks (e.g., single-name concentration, industry-sector diversification in the corporate portfolio, concentration by geographies, business lines and risk types).
  - Basel formulas assume infinite granularity of exposures; S&P’s approach explicitly adjusts for concentration effects.
- Empirical comparison:
  - RAC is only 3 percent higher on average relative to an indicated comparator.
- Constraints and caveats noted:
  - (i) Only banks with an S&P rating would be covered.
  - (ii) The methodology is proprietary and not shared with market participants.
  - (iii) Some regulators and market participants may be uncomfortable with increasing reliance on CRAs.

### Limitations and caveats of the analysis
- Financial statements were used “as is” with no adjustments to harmonize accounting differences across jurisdictions.
- Coverage and comparability constraints arise from differing regulatory reporting, accounting standards, and reliance on proprietary methodologies (e.g., S&P RAC).
- Cross-jurisdictional comparability may be limited by data availability and methodological differences in RWAs and capital definitions.

*Source: APPENDIX II. METHODOLOGY AND SAMPLE DESCRIPTION (extracted from the supplied PDF content).*

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