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EU regulators must measure risk with same yardstick

Basel has examined bank capital ratios, and found twice as much fiddling. The first of two key studies by the global watchdog confirms what many investors have long suspected: lenders reach vastly different conclusions about the riskiness of the same portfolio of trading assets. But Basel has also found that supervisors differ in their conservatism, too. To restore faith in bank capital, both will have to be brought into line.

Banks' capital ratios are based on two key numbers: the total amount of capital, and the size of the balance sheet, adjusted for risk. Since the crisis, the latter measure – known as risk-weighted assets (RWAs) – has been increasingly under fire.

Basel's study of market risk weights, used to gauge the capital that banks need to hold against trading assets, is eye-opening. For BNP Paribas, market RWAs accounted for 10 per cent of trading assets in December, 2011. For UniCredit, the figure was 80 per cent. Part of this is because banks have different types of assets. However, the paucity of public disclosure means it's impossible for investors or anyone else on the outside to tell.

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In an attempt to clear up the confusion, Basel regulators asked 15 banks to run a hypothetical portfolio through their risk models, and calculate how much capital they would have to hold against those positions. One bank – Basel sadly hasn't said which – came up with a figure of €13.5-billion ($18.3-billion). Another concluded it would need more than twice as much.

The difference is partly because some banks use Basel's own standardized model for calculating RWAs, whereas others use their own models more. But regulators are also to blame. Some supervisors demand their charges add on a bigger buffer to the capital they hold in case their models go awry. All supervisors require that their banks multiply whatever capital requirement that comes out of the market RWA calculation by at least three. But some apply a factor of 5.5 times for the same assets.

Basel has two tasks. It has to demand banks apply similar risk models, but also that regulators play ball too. Shifting to a single regulator – as the European Union has proposed with its nascent banking union – should ensure some greater consistency. In the meantime, investors will continue to be suspicious.

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