Fitch Ratings says that banks that use an internal-ratings based approach for regulatory capital may be tempted to increase their capital ratios by reducing the risk weightings they assign to their assets.
While not new, this practice has received more attention in recent weeks because it has been cited by several banks as a way to help meet the European Banking Authority’s temporary 9% core tier 1 capital requirement by mid-2012.
If Fitch deems the adjustments to be excessive, it might lead to a further analysis of the bank’s risk management function.
A bank’s risk weighted capital ratios consists of a numerator, the amount of capital, and a denominator, the amount of risk. The amount of risk is determined by the risk weightings of the assets. Reducing the denominator may give a bank a higher capital ratio, but if it is achieved purely through changing modelling assumptions it does not change the risk profile of the bank. This is therefore likely neutral for a bank’s ratings.
For details, see Fitch: Cutting Risk-Weights to Boost Capital Won’t Alter Risk