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Top 1000 World Banks – The AQR effect sees Europe buck the trend

A rise in risk weightings in western Europe may well indicate the tougher supervision of the European Central Bank, rather than deteriorating asset quality.
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Many regions of the world saw a decline in the ratio of risk-weighted assets (RWAs) to total assets during 2014. This implies that the banks consider the risks on their books to be falling, and enables them to potentially hold less capital. Africa and South America witnessed swings of 6.75 and 5.28 percentage points, respectively.

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Two of the largest banking markets in Africa, South Africa and Nigeria, both enjoyed double-digit declines in impairment charges in 2014, helping to explain the lower risk assessment of their assets. In South America, Colombia enjoyed a similar improvement in impairment charges, but Brazil’s rate of impairment rose slightly, while Mexico’s impairments also increased slightly as a share of total operating income. It remains to be seen whether the confidence signalled by the fall in RWAs to total assets is justified in practice.

By contrast, western Europe showed a 40 basis point rise in RWAs as a proportion of total assets. With the exceptions of Greece and Austria, impairments are improving in the region, but the more conservative risk assessment may have much to do with the asset quality review completed by the European Central Bank (ECB) in October 2014. Many banks, especially in Greece, Portugal and Italy, were required to adjust their non-performing exposure calculations based on tougher criteria than those used by their national supervisors.

With the single supervisor at the ECB taking charge the following month, the more rigorous criteria will become entrenched in financial reporting. The modelling of RWAs in Europe is noticeably more relaxed than in any other region, coming at 35.55% of total assets. Only Japan, at 38.48%, is anywhere near this level.

The US regulators are similarly paying attention to what they consider to be deteriorating underwriting standards, especially in auto lending and leveraged loans. In July 2014, the US Office of the Comptroller of the Currency (OCC) warned banks that falling provisions for loan losses were unsustainable. In the October 2014 Shared National Credits review, the OCC reported increased credit risk in the portfolios of 16 out of the 25 banks active in leveraged finance.

The rise in RWAs as a proportion of total assets was sharper in North America than in Europe, and modelling appears more conservative – RWAs came in at 58.29% of total assets. However, this gap is partly offset by different accounting standards. US generally agreed accounting principles allow banks to net derivative exposures, which are recorded gross under European accounting rules. This reduces the total asset size for the largest US banks that are active in derivative markets.

The sharpest rise in RWAs as a proportion of total assets is in the Middle East, at 65.27 basis points. The region already has the second highest ratio of RWAs to total assets after central and eastern Europe (CEE), and impairments fell in most Middle Eastern markets in 2014. This could signal tougher risk weighting by Middle East banks, but it might also indicate enhanced risk appetite. Many Middle Eastern markets, especially in the Gulf countries, are small and saturated, pushing banks to expand elsewhere. Egypt, Turkey and sub-Saharan Africa have all been targets for acquisitions or branch openings by Gulf state banking groups in recent years. This may mean that Middle Eastern banks are investing in riskier assets in these new markets, hence the rise in RWAs.

Risks are certainly rising in CEE, with conflict-torn Ukraine and sanctions-hit Russia recording two of the highest rises in impairments. However, the CEE region also saw a decline in RWAs to total assets in 2014, suggesting that banks in other markets believe they have cut their risks. Poland, the largest CEE market aside from Russia, in particular enjoyed a healthy fall in impairments in 2014. But that may not be sustainable. The country has a high proportion of mortgages denominated in Swiss francs. With the massive revaluation of the Swiss franc in January 2015, the debt servicing burden for these retail customers has soared, and asset quality may fall sharply.

risk-weighted assets – regional breakdown

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