The Manipulation of Basel Risk-Weights
AbstractIn this paper, we examine the relationship between banks’ approval for the internal ratings-based (IRB) approaches of Basel II and the ratio of risk-weighted over total assets. Analysing a panel of 115 banks from 21 OECD countries that were eventually approved for applying the IRB to their credit portfolio, we find that risk-weight density is lower once regulatory approval is granted. The effect persists when we control for different loan categories, and we provide evidence showing that it cannot be explained by flawed modelling, or improved risk-measurement alone. Consistent with theories of risk-weight manipulation, we find the decline in risk-weights to be particularly prevalent among weakly capitalised banks, when the legal framework for supervision is weak, and in countries where supervisors are overseeing many IRB banks. We conclude that part of the decline in reported riskiness under the IRB results from banks’ strategic risk-modelling.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9494.
Date of creation: May 2013
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Find related papers by JEL classification:
- G20 - Financial Economics - - Financial Institutions and Services - - - General
- 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
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-09-26 (All new papers)
- NEP-BAN-2013-09-26 (Banking)
- NEP-CBA-2013-09-26 (Central Banking)
- NEP-RMG-2013-09-26 (Risk Management)
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