Bank regulatory arbitrage via risk weighted assets dispersion

Giovanni Ferri and Valerio Pesic

Journal of Financial Stability, 2017, vol. 33, issue C, 331-345

Abstract: 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.

Keywords: Regulatory arbitrage; Internal rating based models; Risk weighted assets dispersion (search for similar items in EconPapers)
JEL-codes: G2 G21 G28 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (20)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:33:y:2017:i:c:p:331-345

DOI: 10.1016/j.jfs.2016.10.006

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