Are Risk-Based Capital Requirements Detrimental to Corporate Lending?

Abstract

In this chapter, we summarize the main results of a recent empirical research concerning European banks. We first explore the main drivers of the differences in risk-weighted assets (RWAs) across a sample of fifty large European banking groups. We then assess the impact of RWA-based capital regulations on those banks’ asset allocations in 2008–14. We find that risk weights are affected by bank size, business models, and asset mix. We also find that the adoption of internal ratings-based (IRB) approaches is an important driver of RWAs and that national segmentations explain a significant (albeit decreasing) share of the variability in risk weights. As for the impact of internal ratings on banks’ asset allocation in 2008–14, we uncover that banks using IRB approaches more extensively have reduced more (or increased less) their corporate loan portfolio. This effect is somewhat stronger for banks located in Eurozone periphery countries during the 2010–12 sovereign crisis. We do not find evidence, however, of internal models producing a reallocation from corporate loans to government exposures, suggesting that other motives prevailed in driving banks towards sovereign bonds during the Eurozone sovereign crisis, including the so-called ‘financial repression’ channel.

Credit Risk in European Banks: The Bright Side of the Internal Ratings Based Approach

“…We contribute to the credit risk literature by evaluating the impact of validated IRB models on efficient risk management and by investigating which factors drive IRB adoption at bank level. The accuracy of IRB models has been discussed by few authors indirectly ( Mariathasan and Merrouche, 2014;Mascia et al, 2016;Behn et al, 2016b;Bruno et al, 2016) but, to our knowledge, the only paper assessing their direct impact on credit risk is Erdinc and Gurov's (2016). These scholars find a negative and significant impact of validated IRB models on asset quality at country level.…”

“…It has been argued that, heterogeneous risk weights and discrepancies in RWAs may also stem from differences in the validation process itself (Le Leslè and Avramova, 2012;Arroyo et al, 2012;Ledo, 2011;EBA, 2016, Bruno et al, 2016BCBS, 2016 and2016b) and/or from a different 'supervisory pressure' (Arroyo et al, 2012;Mariathasan and Merrouche, 2014). These 2 These potential flaws have been addressed by the Basel Committee on Banking Supervision that in 2010 has issued a revised regulatory framework (also known as Basel III) and at the end of 2017 has finalized another set of reforms that aim at improving the comparability of capital ratios across banks and limiting the strategic use of internal risk models.…”

“…A number of authors suggests that validated IRB models may bring negative implications, such as : i) opacity in credit risk measurement and lack of comparability of RWAs across banks; ii) incentives and opportunities for risk weights manipulation and regulatory arbitrage; and iii) a bias in asset allocation and a procyclical effect on banks lending policy (Arroyo et al, 2012;Mariathasan and Merrouche, 2014;Bruno et al, 2015;Ferri and Pesic, 2016;Beltratti and Palladino, 2016;Behn et al, 2016a;Pèrez Montes et al, 2016;Berg and Koziol, 2017). While the negative implications of the IRB framework have been thoroughly discussed in the literature, few studies have indirectly investigated whether such models accurately measure risk and contribute to the adoption of stronger risk management practices among banks,thus improving banks' resilience, as meant by the regulators (Mariathasan and Merrouche, 2014;Mascia et al, 2016;Behn et al, 2016b;Bruno et al, 2016).…”

“…Data on the use of validated IRB models are rather scant and display significant heterogeneity across countries. According to national supervisory authorities' data 1 , at the end of 2013, 46% of the overall capital that European banks were required to hold was generated using the IRB approaches (Resti, 2016). In some countries like Austria, Greece, Italy and Portugal, internal 1 Data refer to a sample of 105 banks from 21 European countries and account for around 70% of total European banking assets.…”

Banking business models and risk: Findings from the ECB's comprehensive assessment

“…See for example Vallascas and Hagendorff (), Mariathasa and Merrouche (), Beltratti and Paladino (), Behn, Haselmann, and Vig (), Bruno, Nocera, and Resti (), Ferri and Pesic (), among others.…”