Revealing the secrets behind RWA vanishing tricks

Duncan Wood, editor, Risk magazine

It's not hard to understand the scepticism about risk-weighted asset (RWA) numbers. They can be very different at banks that appear fairly similar and even zip around at the same institution from one period to the next – analysts at Barclays revealed last year that the risk-weight used for highly rated corporate loans at Commerzbank and UBS jumped almost 70% between 2010 and 2011, while falling 30% at Crédit Agricole.

So, when a bank claims to have cut RWAs – thereby reducing its regulatory capital requirement – the right question is not ‘by how much?’ but, simply, ‘how?’ What, exactly, has the bank done?

That is a question the Risk editorial team asked a lot during this year’s awards process. In some cases – as with our derivatives house of the year, Credit Suisse – the answers were reassuringly simple, even if the path leading to that outcome was sometimes tough to follow. Transactions were unwound, thousands of them; messy, capital-intensive trades have been novated, while others have been moved into clearing; uncollateralised business is being avoided. In other words, some banks are doing things that look like genuine attempts to reduce risk.

They should be more upfront about it. In the pre-crisis years, the industry did a bad job of explaining what the derivatives business was about, which contributed directly to its post-crisis downfall. Now, something similar is happening. Banks are quick to boast about RWA cuts, but slow to explain how they were achieved.

If this carries on, the industry will again find terms being dictated to it. Credit Suisse and UBS have been more transparent than most –  largely because they had to move earlier. But they still haven’t been transparent enough for Switzerland’s central bank. In June last year, the vice-chairman of its governing board, Jean-Pierre Danthine, told a press conference that the two banks should start calculating their RWAs using standardised approaches, in parallel with their modelled capital figures. That would allow the two measures of risk to be compared and “enable the ongoing reduction of risks to be presented more transparently”, he argued.

When a bank claims to have cut RWAs, the right question is not ‘by how much?' but, simply, ‘how?'

Many banks hate the idea, but it was also included in the Basel Committee on Banking Supervision’s review of its trading book rules last May – and will no doubt be one of the options regulators consider once they have published the results of their year-long RWA benchmarking exercise, which could arrive within weeks.

One alternative is for banks to speak up – in simple terms – about the efforts they are making to reduce risk in their investment banking divisions. If they don’t, then people might conclude they have something to hide.