Risk Weights Assets (RWA) allocate an amount of capital to the assets held by a financial institution as a function of their risk perception and the origination nature (the higher the perceived risk, the higher the risk weight). RWA are core input in the
calculation of a financial institution capital ratio and were first introduced in Basel I
Anyways, under Basel III RWA is changed to capture market risk and counter party related risks which was not available in Basel II. Also Basel III stresses the integration between liquidity and credit risk which need to manage from an enterprise wide context
and hence banks need to have enterprise wide capital ratio calculation framework and reporting infrastructure. It means banks need to focus on maximizing the capital ratio which is heavily dependent on RWAs.
Numerous studies have expressed concerns about the consistency of RWA calculation, specifically concerning its reliability and accuracy of capital ratio, its lack of cyclicality and its usage as an indicator to measure balance sheet. It is observed that the
differences between the average RWA/TA ratios (“RWA density”) across regions are significant, prompting questions about consistency across the RWA methodologies used by banks in different jurisdictions , and casting doubts on the reliability of banks’ capital
ratios. For example : RWA density is different across North America, Europe and Asian institutions. European banks have, on average the lowest RWA density versus Asian and North American institutions (36%, 50%, and 58% respectively). The below are some of
the factors influencing RWA :
- Regulatory Framework
- Supervisory Framework
- Accounting Framework
- Legal Framework
- Economic Cycle
- Business Model
I do understand that we would expect some degree of RWA differences to remain. This would reflect bank's different business models and risk profiles, but also account for different views on risks among regulators. Some variations among estimates of RWAs
for similar risks may be acceptable and contribute to financial stability, through the co-existence of different business choices, models and risk appetites. A uniform risk measurement might lead to herd behavior and be detrimental to some asset classes (reduction
in exposures), while others could become over-crowded.
The main aim of reforming RWAs is not to seek a full harmonization, but to ensure a greater level of consistency in methodologies and higher transparency in the outputs, for banks and their supervisors.