Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/283007 
Year of Publication: 
2024
Series/Report no.: 
Deutsche Bundesbank Discussion Paper No. 02/2024
Publisher: 
Deutsche Bundesbank, Frankfurt a. M.
Abstract: 
The internal ratings-based (IRB) approach maps bank risk profiles more adequately than the standardized approach. After switching to IRB, banks' risk-weighted asset (RWA) densities are thus expected to diverge, especially across countries with different supervisory strictness and risk levels. However, when examining 52 listed banks headquartered in 14 European countries that adopted the IRB approach, we observe a downward convergence of their RWA densities over time. We test whether this convergence can be entirely explained by differences in the size of the banks, loss levels, country risk, and/or time of IRB implementation. Our findings indicate that this is not the case. Whereas banks in high-risk countries with less strict regulation and/or supervision, reduce their RWA densities, banks elsewhere increase theirs. Especially for banks in high-risk countries, RWA densities seem to underestimate banks' economic risk. Hence, the IRB approach enables regulatory arbitrage, whereby authorities may only enforce strict supervision on capital requirements if they do not jeopardize bank existence.
Subjects: 
Capital regulation
credit risk
internal ratings-based approach
regulatory arbitrage
risk-weighted assets
JEL: 
G21
G28
ISBN: 
978-3-95729-971-0
Document Type: 
Working Paper

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