Comparing risk-weighted assets: the importance of supervisory validation processes

Abstract

This article analyses the problems of using the risk-weighted assets (RWA) density ratio – defined as the ratio of RWA to total assets – to make comparisons across banks, as is frequently done by banks themselves and analysts. An international comparison is made of 16 European banks, based on public information, from which it is concluded that a significant part of the differences in RWA density are a consequence of differences in the type of business involved. In particular, the greater the weight of credit risk in a bank’s balance sheet the higher will be its RWA density. We propose alternative RWA density ratios and illustrate them with the results for Spanish banks using confidential data. We show that public information cannot be sufficiently detailed to enable differences across banks arising from their risk profiles to be distinguished from others attributable, for example, to different interpretations of solvency rules by banks or supervisors. Therefore, the supervisory review process and the progress in its inter-jurisdictional harmonisation are especially important. The paper concludes with a review of the process used by the Banco de España for the supervisory validation of Internal Ratings Based (IRB) approaches for credit risk.