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Some news from outside London.
Earlier this week, Coventry Building Society announced that its CET1 capital ratio -- a measure of how leveraged the business is, in relation to the risk of its assets -- was 1.6 per cent lower than previously advertised.
This took the ratio from 34.2 per cent to 32.6 per cent, which is still far above the low-teen levels at most major banks.
The mistake echoes one made by Metro Bank earlier this year, when it understated its total risk-weighted assets. In that case, its capital ratio went from 15.3 per cent at the end of 2017 to 13.1 per cent.
Risk-weighted assets -- the common denominator in each case (no pun intended) -- are a kind of compromise in banking regulation, compared to a flat leverage ratio of the kind advocated by many critics of the financial system.
Despite the errors, in neither case did the offender’s capital position breach or come close to the minimum level. Instead, the incidents serve to illustrate the byzantine nature of regulation that has taken shape over a decade when bank balance sheets have come under much greater scrutiny.
Risk-weightings can be calculated through internal models, as per Coventry’s statement on Wednesday (which, overall, gives you a flavour of just how arcane this field has become):
The Society uses Internal Ratings Based ("IRB") models to calculate its Risk Weighted Assets ("RWAs") and is seeking to update these models to ensure compliance with upcoming Basel III reforms2. During the process of transitioning models, the Society has identified an omission in connection with its historic calculation of its RWAs. Specifically, the necessary 6% scalar was not applied to the core IRB model outputs. The core IRB models themselves are not impacted. Application of the 6% scalar would have increased total RWAs by 4.6%, resulting in the 1.6% reduction in the CET1 ratio, as at 30th June 2019. The previous guidance provided by the Society on the transitional and end-state impact on its CET1 ratio of standardised floors within Basel IV remains unchanged.
As Fitch Ratings said of the Coventry incident, the issue “highlights the challenges of operational risks related to regulatory reporting”. The FT’s Patrick Jenkins pointed out earlier this year that risk-weightings have themselves come under greater scrutiny, with the BIS weighing in.
Fitch added, of Coventry, that there “is no indication that the miscalculation of risk-weighted assets is indicative of systematic weakness in risk and reporting tools”.
For hypothetical mistakes elsewhere, though, the question is whether the numbers are now so layered in detail that it’s not straightforward to identify an error in the first place.
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