4 “Risky” questions to ask about risk-weighting methodology

Written by Shea Dittrich, director at Sageworks

With the proposed changes to the risk-weighting methodology, regulatory agencies are moving towards an approach that measures capital by risk. This new method allows banks to implement strategic plans—what concentrations in which to focus lending, for example—that take into account their business objective and appetite for risk.

While there may be revisions to the new risk-weighting proposal, it’s evident that regulatory agencies will be soon making a change to how banks measure risk, particularly risk in the portfolio.

To prepare, financial institutions should ask the following questions:

1. How sensitive is our loan portfolio to the proposed changes in the standardized risk-weighting approach?

2. How do the potential changes affect our current capital position?

3. Does our strategic plan address capital needs concurrent with our appetite for risk?

4. Have we stressed our capital situation in light of potential changes?

As financial institutions move toward a more centralized process to handling different types of risk, they need to understand thoroughly their risk appetite and, concurrently, be certain that board members understand. Capital and risk will go hand in hand, and senior management, boards and regulators all will be held accountable to ensure that 1) appropriate capital levels are in place based on the bank’s risk and 2) the different constituents work together to develop a strategic plan for each institution that incorporates a change in the approach to risk-weighting.

Download the latest whitepaper, “Risk-Weighted Assets: 4 ‘Risky’ Questions Regulators Want You to Ask” to learn what the proposal is and how financial institutions can start to prepare.