Comparability of Basel risk weights in the EU banking sector

Our aim is to quantify the variability across EU countries evident in the risk weights (RW) applied by banks to their exposures. To this end, we use a publicly available panel dataset which provides granular portfolio-by-portfolio data for major EU banks and covers six periods between 2013 and 2016. In line with the Basel regulatory capital framework, RW should adequately mirror the risk of the obligations. One meaningful indicator of the underlying risk is the share of nonperforming loans (NPLs) in a given portfolio. We show that a good portion of RW variability can be explained by portfolio- and destination-specific risk indicators such as macroeconomic indicators and NPL ratios. In our analysis, we find that it is not statistically significant that large banks are better able to push down RW (after controlling for underlying credit risks). It is of marginal statistical significance that banks with low common equity tier 1 (CET1) ratios employ RW that are lower than would be expected from the underlying credit risk. We observe, however, statistically significant and economically important differences with regard to the country where a bank is headquartered. The paper sets forth evidence that implementation standards differ from jurisdiction to jurisdiction, thus motivating initiatives by the EBA and the ECB to strengthen harmonization.