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Do European banks manipulate risk weights?

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  • Barucci, Emilio
  • Milani, Carlo

Abstract

Exploiting the information provided by the 2014 Comprehensive Assessment of the European Central Bank and the European Banking Authority, we provide new evidence on the manipulation of risk weights by banks. Concentrating our attention on credit risk density (non-defaulted risk weighted loans over non-defaulted loans), we confirm that the internal rate based approach (mostly the advanced) is used by banks to manipulate risk weights. Moreover, we find that risk weights are mostly underestimated in case of loans in the domestic market and in case of loans to the corporate and retail sectors—i.e. when asymmetric information is significant. We also show that the attitude to underestimation of risk weights is not due to incorrect assumptions of banks' models. Our evidence supports the hypothesis that national supervisory authorities are captured by local banks.

Suggested Citation

  • Barucci, Emilio & Milani, Carlo, 2018. "Do European banks manipulate risk weights?," International Review of Financial Analysis, Elsevier, vol. 59(C), pages 47-57.
    • Handle: RePEc:eee:finana:v:59:y:2018:i:c:p:47-57
    DOI: 10.1016/j.irfa.2018.07.002
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    5. Vincenzo Russo & Valentina Lagasio & Marina Brogi & Frank J. Fabozzi, 2020. "Application of the Merton model to estimate the probability of breaching the capital requirements under Basel III rules," Annals of Finance, Springer, vol. 16(1), pages 141-157, March.

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    More about this item

    Keywords

    Bank regulation; Risk weight; Basel II; European Central Bank;
    All these keywords.

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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