Banks See Pressure on Capital Ratios as ECB Tackles Risk Models

  • Central bank to start review of lenders’ internal models
  • Some banks take independent action ahead of ECB review

Some European banks are seeing their capital ratios come under pressure as the region’s top supervisor takes a more conservative view of their risk models.

Last month, the European Central Bank raised the risk-weightings which determine capital at Finland’s biggest financial services group after finding “shortcomings” in its models. Lenders including Bank of Ireland have started to take similar action of their own before the ECB starts to visit 68 banks in 15 countries next month to review their internal models.

Risk models designed by banks are at the heart of concerns among investors and regulators that lenders are putting short-term profitability ahead of adequate risk assessment. The ECB’s review is getting underway as the chances of success of a deal between global regulators to stop banks from gaming the system looks uncertain.

“We remain extremely cautious as to its outcome,” Jeremy Masding, the chief executive officer of Permanent TSB Group Holdings Plc, said of the ECB review on a March 8 conference call with analysts.

Bilateral Talks

The Dublin-based lender may have to add as much as 1.5 billion euros ($1.6 billion) to its risk-weighted assets after bilateral talks with the ECB, Masding said. If that had taken place at the end of last year, the bank’s 17.2 percent common equity Tier ratio would be about 2 percentage points lower, calculations by Bloomberg News show. The CEO declined to say what the effect of the ECB’s sector-wide review could be for his company.

Stretching into 2019, the ECB’s review will cover all internal models for market and counterparty credit risk as well as at least 60 percent, or about 7 trillion euros, of credit risk exposure measured by internal ratings.

Deutsche Pfandbriefbank AG, a German real estate lender, will have to revisit its capital goals if the ECB’s “more standardized approach” raises its risk-weightings, CEO Andreas Arndt told analysts on a March 8 conference call.

“We do have a very conservative portfolio with appropriate and according risk weights,” Arndt said. “But there are different benchmarks in the market which we will have to observe.”

While the review plays into the ECB’s goal of harmonizing supervisory practices in the euro area, the central bank says models are allowed to differ and the focus is on reducing “unwarranted” variability

Revised Measure

It’s already had an effect. Bank of Ireland revised its risk calculation for non-defaulted Irish mortgages in December, cutting its common equity Tier 1 ratio, a key measure of financial strength, by about 65 basis points.

Separately, Finland’s OP Financial Group said in February that the ECB raised its risk-weights on retail exposures for a period of 18 months, lowering the CET1 ratio by less than 2 percentage points from 20.1 percent at the end of December.

Other banks have played down the potential effect from the ECB review, with Germany’s Deutsche Bank AG saying March 6 that it doesn’t expect a “material impact.”

Still, investors may not get the whole picture. In addition to action the banks have already taken, the firms won’t necessarily disclose data which is sufficiently granular to show increases in risk-weighted assets specifically due to the review.

Meanwhile, members of the Basel Committee on Banking Supervision are struggling to complete a deal to constrain banks from using their risk models to reduce their capital requirements. The U.S. has pushed for a so-called floor, a check on how much lower the risk estimates can be in relation to standard formulas set by regulators. The European Union, whose major banks would take the biggest hit under the new rules, is pushing for a lower floor.

The ECB says its review addresses the concerns some regulators have about internal risk models and that it wants “to contribute to ensuring that models are indeed being used appropriately.”

The sector-wide model review will consume about 15 percent of the ECB’s budget for its banking supervision arm this year, its single-biggest project since that unit’s inception in late 2014.

“That’s a major exercise for the banks as well as for the regulator,” said Arndt. “It certainly has something sportive.”

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