New methods for banks' risk weights and capital requirements

Finansinspektionen (FI) is publishing two consultation memorandums today that will raise the capital requirements primarily for exposures to corporates for banks that use the internal ratings-based approach.

 

The increase is the result of a more conservative calculation of probability of default and the introduction of a maturity floor. FI's new methods will be implemented in 2016.

Risk-based capital requirements for banks are significant for financial stability and the manner in which the financial markets' function. Larger Swedish banks currently use an internal ratings-based (IRB) approach to calculate their capital requirements.

The IRB approach contributes to good risk management at the banks since it requires them to hold more capital if they lend to customers with higher risk. The approach also introduces incentives for the banks to try to reduce their risk weights, and thus their capital requirements, more than what is justified based on the banks' actual risk level.

FI is now publishing two consultation memorandums. They describe the methods FI will use to remedy the main problems FI has observed in the banks' implementation of the IRB approach. In brief, these methods entail that:

  • The banks' estimates of probability of default should anticipate a larger proportion of economic downturns. More specifically, every fifth year should be considered a "downturn year".
  • A maturity floor of 2.5 years is implemented under Pillar 2 for banks that have authorisation to use the advanced I approach.

The new method to calculate default risk is expected to raise the risk weights for all banks that use the IRB approach, and the risk weights for exposures to corporates are expected to exceed 30 per cent for all banks. The maturity floor is expected to raise the capital requirements by up to around 0.5 percentage points.

The banks that are authorised by FI to use the IRB approach are Swedbank, Handelsbanken, Nordea, Landshypotek, Länsförsäkringar Bank, SBAB, SEB, Swedish Export Credit Corporation (SEK), Volvo Finans and a number of savings banks. These banks will need to change to varying degrees the methods they use to calculate probability of default. The four major banks, Handelsbanken, Nordea, SEB and Swedbank, are authorised to use the advanced IRB approach for exposures to corporates and will also be subject to the maturity floor.

FI expects the positions it describes in the memorandums, after taking into consideration consultation feedback, will be implemented into the banks' capital requirements during 2016.

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