The purpose of this interim report on the EBA’s investigation into what drives differences in RWA outcomes is to inform interested parties about the EBA’s analysis of RWA, and assist them in understanding the scope of the work undertaken.

After finalising the 2011 EU-wide stress test and the recapitalisation exercise, the EBA turned its attention to understanding RWA. The aim is to identify whether there are material differences in RWA outcomes and, if so, to discover the sources of these differences and whether they are justified by fundamentals or are related to differences between banks and supervisory practices.

One key objective of this report is to illustrate the complexity behind differences in RWA and to emphasise that there is not necessarily a right and wrong answer in RWA outcomes. In-depth analysis can shed some light on what drives differences in RWA outcomes. This is useful for understanding the risk weights in different banks. Since this is an interim report, no policy conclusions can be drawn from the analysis.

The EBA’s stress test and recapitalisation exercise have helped strengthen and enhance the consistency of thae numerator of the capital ratios, whilst also improving broader understanding of capital levels through improved transparency and consistency of definitions. Following on from this,questions have been raised as to why there are significant differences in the denominator of the capital ratios (the capital requirements) and material differences in the regulatory parameters (PDs and LGDs) of the banks. The EBA is investigating these issues and plans to provide better information about them in due course in 2013 (see below work-plan).

As noted in the past, differences in risk parameters and capital requirements between banks are not a sign of inconsistency per se. For example, the composition of portfolios may differ across banks as the result of differences in markets (e.g. geography), risk appetite or borrower selection criteria. However, a substantial divergence between banks may signal that the methodologies used for estimating risk parameters by some banks will require further analysis.

Initially, the EBA has focused its analysis on credit risk, mainly IRB, postponing the work on the trading book. The report covers analysis of the risk parameter estimates used in the RWA and EL calculations and investigates to what extent any differences may reflect individual experience and risk management practices, different features of the internal models, and/or varying interpretation/practical application of the Capital Requirements Directive (CRD). Some attention has been given to the computation of RWA under the standardised approach, with particular reference to risk classification, usage of external ratings (ECAIs) and credit risk mitigation techniques.

After reaching an enhanced understanding of what drives differences in RWA, a number of options will be explored to address specific concerns. These include using existing CEBS/EBA Guidelines, where appropriate, to enhance convergence in the computation of RWA, and improve Pillar 3 disclosures, validation and ongoing monitoring of internal models.