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The Manipulation of Basel Risk-Weights

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  • Mariathasan, Mike
  • Merrouche, Ouarda

Abstract

In 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 Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9494.

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Date of creation: May 2013
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Handle: RePEc:cpr:ceprdp:9494

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Keywords: Basel II; capital regulation; internal ratings-based approach;

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Cited by:
  1. Lukas Scheffknecht, 2013. "Contextualizing Systemic Risk," ROME Working Papers 201317, ROME Network.
  2. Horvath, B.L., 2013. "The impact of Taxation on Bank Leverage and Asset Risk," Discussion Paper 2013-076, Tilburg University, Center for Economic Research.
  3. David G. Mayes & Hanno Stremmel, 2014. "The Effectiveness of Capital Adequacy Measures in Predicting Bank Distress," Chapters in SUERF Studies, SUERF - The European Money and Finance Forum.
  4. Harald Hau & Sam Langfield & David Marques-Ibanez, 2013. "Bank ratings: what determines their quality?," Economic Policy, CEPR & CES & MSH, vol. 28(74), pages 289-333, 04.

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