24 trade & finance
What is the reason for these differences in risk-weighted asset calculations? There are many potential drivers, and not all of them are bad.
A significant part of the variation is due to supervisory choices in the implementation of the regulations. Examples would be: policy decisions to restrict modelling options( eg. to disallow any diversification benefit between types of risk) or to apply stricter supervisory multipliers.
Other drivers include the modelling choices of individual banks. Some of these are unavoidable. Models are statistical tools that inevitably rely on samples of data. The estimation noise can be significant and cannot be reduced beyond a certain point( for instance, by enlarging the sample over which the model is estimated). In the absence of an objective measure of risk, some difference in opinion between banks is not only legitimate but also welcome: diversity is necessary for two-way markets.
But certain other modelling choices by the banks are more problematic because they reflect strategic behaviour that seeks to minimise regulatory capital requirements. These choices potentially overstate bank solvency, undermine transparency, weaken market discipline and make the playing field uneven. They are unwelcome. The issue is how best to address the bias embedded in banks’ incentives to‘ over-optimise’ regulatory capital. Some solutions may be as simple as standardising the timespan of the data used for modelling.
The Basel Committee is studying these different drivers to get a better understanding of their relative importance and to design an appropriate response. Help from the industry is critical, because it is in everybody’ s interest to make sure that the framework is implemented consistently.
The solution will necessarily be multifaceted. Some of the options the Basel Committee will be considering include the following:
• Improving public disclosure and regulatory data collection to help understand what risk- weighted assets are and how they are derived. This can build on the work of the Enhanced
Disclosure Task Force, which has come up with many useful ideas.
• Narrowing acceptable modelling choices for banks and developing supplementary measures, such as improved supervisory safeguards and backstops.
• Providing additional supervisory guidance for model approvals.
All these options have costs, and some participants will inevitably be reluctant to move from the status quo. But an uneven playing field, and mistrust in reported bank capital, impose high costs that are best avoided. So we should see these costs as a necessary investment in a regulatory system that is better for all.
Financial markets fragmentation
I have been also asked to say a few words about fragmentation. My starting point here is the premise that consistent, globally applied regulatory standards are not only imperative for global financial stability but they will also help to reduce the pressures that drive the fragmentation of financial markets. Signs of fragmentation have already appeared, particularly in the euro area.
… there are very large differences across banks in the way they riskweight their trading book exposures
Containing fragmentary pressures is important for a number of reasons. First, we should be very careful not to lose the benefits of globalisation and financial integration. Ultimately, these ensure that capital is allocated efficiently at the global level, supporting growth and development. Second, fragmentation can prevent the proper transmission of monetary policy, constrain the supply of credit and in general amplify divergent economic and financial conditions, delaying the necessary normalisation of economic conditions. This is especially the case in a currency union such as the