The Coming of Basel 4: A New internal Rating Based Approach Study

Niklas Bork Petersen & Giovanni Romio

Student thesis: Master thesis

Abstract

This paper aims to outline the regulations that have been affecting banks in the past decades. Additionally, Basel IV is supposed to put a severe limitation on the use of the IRB approach for the calculation of assets’ risk weights. The aim of this paper is to show how risk weight averages, derived using the Internal Rating Based approach, are significantly smaller than risk weight averages of a bank with a similar pool of assets, that were calculated using the Standard Model.
For this purpose, we infer the volatilities of the banks’ assets and compare them to the applied RWA. This should highlight if they are approximately representing an appropriate measure of risk. The results give the impression that the IRB approach might not be consistent in evidencing the real sensitivity banks’ assets have to market fluctuations. Combined with a cross country analysis, the potential effects on the banking systems mostly relying on IRB seem to be also that could be more impacted on the regulatory capital by Basel IV.
After thorough analysis we conclude that RWA not reflecting the actual riskiness of the financial institutions assets. This conclusion is based on the implied asset volatility used as a benchmark to an objective risk measure. Furthermore, the severity of the impact from Basel IV is dependent on the amount of IRB a bank use because Basel IV are presumably implementing a simplified way of calculating RWAs. This is further researched in a cross-country analysis where we can conclude that countries such as Denmark and Sweden are facing problems with the implementation of Basel IV because if the amount of IRB these countries use to calculate their RWA.

EducationsMSc in Finance and Investments, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2018
Number of pages135