Major euro area banks underestimate risk, according to ECB

275 billion euros in their risk assets

Big euro area banks have been declaring a deficit of 275 billion euros in their risk assets by using their own models to quantify potential losses, the European Central Bank said on Monday.

Since the financial crisis of 2008, regulators around the world have scrutinized the internal models that large banks use to calculate how much risk is on their balance sheets and, in turn, how much capital they need.

A five-year review carried out by the ECB has revealed that the major banks in the euro area have underestimated their risk-weighted assets by € 275 billion, or 12%, for example, by undervaluing losses in case of bankrupt a borrower.

This reduced the ratio between the capital held by these banks and their risk assets, a key indicator for measuring the strength of a lender, by 70 basis points on average between 2018 and 2021.

“Banks are following up to correct deficiencies and fully comply with requirements,” Andrea Enria, chairman of the ECB’s supervisory board, said in a press release.

The ECB said “further improvement” was necessary in some areas, for example to ensure that the probability of default assumed by banks is in line with long-term averages and is appropriately conservative.

The way borrowers are rated must also “change or adapt,” added the euro area’s top banking supervisor.

The ECB’s Selective Review of Internal Models (TRIM) included 65 large banks in the euro area. Germany was the most represented country, with 14 entities.

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