Back to the roots of internal credit risk models: Does risk explain why banks' risk-weighted asset levels converge over time?

Victoria Böhnke, Steven Ongena, Florentina Paraschiv and Endre J. Reite

Journal of Banking & Finance, 2023, vol. 156, issue C

Abstract: The internal ratings-based (IRB) approach maps bank risk profiles more adequately than the standardized approach. After switching to IRB, banks' risk-weighted asset (RWA) densities are thus expected to diverge, especially across countries with different supervisory strictness and risk levels. However, when examining 52 listed banks headquartered in 14 European countries that adopted the IRB approach, we observe a convergence of their RWA densities over time. We test whether this convergence can be entirely explained by differences in the size of the banks, loss levels, country risk, and/or time of IRB implementation. Our findings indicate that this is not the case. Whereas banks in high-risk countries with lax regulation, reduce their RWA densities, banks elsewhere increase theirs. Especially for banks in high-risk countries, RWA densities underestimate banks' economic risk. Hence, the IRB approach enables regulatory arbitrage, whereby authorities only enforce strict supervision on capital requirements if they do not jeopardize bank viability.

Keywords: Capital regulation; Credit risk; Internal ratings-based approach; Regulatory arbitrage; Risk-weighted assets (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0378426623001905
Full text for ScienceDirect subscribers only

Related works:
Working Paper: Back to the roots of internal credit risk models: Does risk explain why banks' risk-weighted asset levels converge over time? (2024)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:156:y:2023:i:c:s0378426623001905

DOI: 10.1016/j.jbankfin.2023.106992

Access Statistics for this article

Journal of Banking & Finance is currently edited by Ike Mathur

More articles in Journal of Banking & Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().