Given the recent financial report regarding the UK’s Metro Bank accounting failure, one of the most renowned financial regulators in the world has given a directive to allow for external auditing checks on the riskiness of banks’ loans.
According to Bill Coen, the Basel Committee on Banking Supervision secretary-general, auditors should be given the mandate of evaluating the bank’s calculations. This step will help eradicate cheating and errors in order to alleviate such a crisis that has been experienced in the 9-year old bank as well as other financial lending institutions.
In reference to Mr. Coen statement to the Financial Times, it’s a critical investment prospect to allow external auditors to assess a bank’s risk weightings.
Mr. Coen further adds that this decision will strengthen the security measures for financial assets making sure that bank lending is given the proper risk weighting it deserves.
The Risk Weighted Assets Loophole
Truth be told, risk-weighted assets (RWA) provide crucial financial information that is very vital in determining the equity capital that a bank should have. And, given the rising cases of banking errors, increased appeals for reforms have been witnessed throughout the world.
Capital levels are vital to banks’ robustness. According to the report, the Metro Bank incident came to light in January where the bank is said to have miscategorized a range of mortgage thereby alarming shareholders and triggering friction with the financial regulators.
Last week, Metro said to have fixed the allotting of the correct risk weighting and errors to those loans. This decision inflated its assets by 11% and prompted a £350m capital increase. Metro says it has experienced a Shares reduction by ½ over the past six weeks.
After the Metro financial incident, the Institute of Chartered Accountants in Wales and England encouraged the idea of auditing the RWAs calculations. However, bankers disregarded the proposal claiming that it was self-interested since the auditing RWAs would result in additional complex fee-based work.
Policymakers are already criticizing the efficiency of the audit profession, especially in the UK. The issue of the trustworthiness of the RWA calculations follows another incidence involving bank lending risk that was usurped by the IFRS9 international accounting rule.
This rule was introduced in 2018, and it directs banks to set apart credit loss provisions prior to the crises of losses instead of waiting until the loss occurs.
The Alarm on Divergent Views
Mr. Coen’s backs up the Basel Committee’s longtime idea for RWA audits due to the increased and unexplained divergences on how different banks view and judge the riskiness concerning different types of loans.
The Metro bank which is among the minor and fastest growing financial institutions in the UK made a mistake of positioning some loans into the standard risk-weighting level.
Usually, large and complex banks employ sophisticated risk models. And, according to financial experts, these models are effective and can apply in the RWA calculations.
Regulators expected to approve these models prior to use but currently, the performance of these models from year to year is not evaluated.
Some bank managements are not into the use of the RWA models which are designed to reduce risk weighting and capital necessities in sections of lending in cases where losses tend to be low. Furthermore, these models do not reflect the probability of a change in the credit cycle.
According to the chairman of one of the largest European lenders, it’s a wise decision to allow the auditing of risk weights. This statement to support audits in banks risk weighting comes after he witnessed a decline in his group’s mortgage risk weighting by ⅓ over the past few years.