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Contribution Details

Type Journal Article
Scope Discipline-based scholarship
Title Back to the roots of internal credit risk models: Does risk explain why banks' risk-weighted asset levels converge over time?
Organization Unit
  • Victoria Böhnke
  • Steven Ongena
  • Florentina Paraschiv
  • Endre J Reite
Item Subtype Original Work
Refereed Yes
Status Published in final form
  • English
Journal Title Journal of Banking and Finance
Publisher Elsevier
Geographical Reach international
ISSN 0378-4266
Volume 156
Page Range 106992
Date 2023
Abstract Text 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.
Digital Object Identifier 10.1016/j.jbankfin.2023.106992
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Keywords Capital regulation, Credit risk, Internal ratings-based approach, Regulatory arbitrage, Risk-weighted assets