December 11, 2019 /08:48 AM / By Fitch Ratings /
Header Image Credit: Fitch Ratings
Approaches to determining risk-weighted assets (RWA) vary significantly between emerging markets and can impede capital comparisons between banks unless adjustments are made, Fitch Ratings says in a new report. Leverage and risk-weight calculation (and consideration of the ratio of RWAs to total assets, or "RWA density") can therefore be an important adjusting factor when we assess banks' capitalisation.
Differences between two banks' RWA densities may reflect true differences between the banks' asset composition and risk, which are valid when comparing their capital positions. But the differences may also reflect different approaches to calculating RWAs, which could distort comparisons. Our review highlights that jurisdictions apply differing discretions and options under Basel standards, determine asset risk charges based on varying credit rating scales, or apply idiosyncratic country-specific rules. Banks may also use their own internal risk-based model to calculate RWAs rather than a standardised approach, exacerbating the lack of comparability.
We analysed key RWA differences in 16 emerging markets, including Brazil, China, India, Indonesia, Russia, South Africa and the UAE. The average RWA density was 67% at end-2018 but there was significant dispersion around this.
Russia had by far the highest RWA density of almost 100%, followed by Georgia and Belarus, both above 80%. Turkey was also close to this mark. At the other end of the spectrum was Brazil, with a RWA density of below 50%. Poland, India, South Africa, Nigeria and Ukraine were also notably below the average.
India uses national ratings for weighting exposures to domestic companies, without any mapping to an international rating scale. This significantly lowers risk-weights. For example, local companies rated 'AA-' and above on the national scale have a risk-weight of only 20%, while if international ratings were used or national ratings were properly mapped to international ones, the risk-weight could be 100%. Indonesia and China also use national ratings, but apply them to local-currency exposures only.
Different asset compositions largely explain the deviation from the average for Nigeria, Ukraine, Turkey and to a large extent for Brazil, where about 40% of assets are low risk-weighted reverse repo exposures backed by sovereign bonds. Large banks in South Africa use internal risk-based models, explaining the relatively low average risk-weights. In Poland, the low RWA density is mainly driven by significant exposures to local-currency domestic government bonds (about 18% of assets; zero risk-weight) and local-currency mortgages (about 15%; low risk-weights).
Russia has a very conservative Basel II-based risk-weighting framework, as well as some specific high risk-weights for certain risky retail loans and foreign-currency exposures. The gradual transition to a Basel III-based framework starting in 2020 will result in a lowering of risk-weights as certain exposures are weighted lower based on individual risk assessment rather than issuer ratings. However, Fitch assesses capitalisation in Russian banks (as well as banks in Azerbaijan, Belarus, Georgia, Kazakhstan, Ukraine and Uzbekistan) based primarily on IFRS statements. Such statements are different from regulatory accounts and typically include capital ratio calculations based on less conservative risk weightings.
Georgia and Belarus's high RWA density reflects the high risk-weights imposed on foreign-currency loans to mitigate high dollarisation risks. In Belarus risk-weights up to 625% are applied to loans issued at interest rates significantly above the market rate. In Uzbekistan about 20%-40% of sector loans are 20%-weighted as legacy problem exposures guaranteed by the government: the state plans to transfer these loans to the sovereign wealth fund, after which the density should increase.
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