NatWest reaps benefits of PRA’s market risk relief

Suspension of capital multiplier contributes to £1.5 billion of RWA savings

Risk-weighted assets for trading exposures fell 11% at NatWest Group over the three months to end-June, partly due to market risk capital relief measures introduced by the Prudential Regulation Authority (PRA).

Market RWAs at the UK bank totalled £11.5 billion ($15.1 billion) in Q2, making for a minimum risk-based capital requirement of £922 million. RWAs amounted to £13 billion at end-March. The bank said the UK regulator’s decision to mitigate the effects of coronavirus-induced market volatility by temporarily freezing the multiplier applied to calculate banks’ value-at-risk (VAR) based capital charges drove the quarter-on-quarter decrease.

This relief takes the form of a deduction to banks’ risks-not-in-VAR (RNIV) charge. In Q2, RNIV RWAs fell 92%, to £61 million. This more than offset an 8% rise in VAR-based RWAs to £2.5 billion. RWAs to account for the incremental risk charge (IRC), and those calculated using the standardised approach, also fell, by 17% and 29% respectively.

 

NatWest said the drop in standardised RWAs followed a reduction in the amount of securitisations and loans held in the trading book, and the fall in IRC RWAs due to a sloughing off of Asia-Pacific and eurozone bonds.

The fall in market RWAs contributed to an overall reduction in group-wide RWAs of 2% quarter-on-quarter, to £181.5 billion. This helped improve NatWest Group’s Common Equity Tier 1 (CET1) capital ratio to 17.2% from 16.6% at end-March.

What is it?

Market RWAs calculated under the internal model approach consist of four components – a VAR- and stress VAR-based requirement, an incremental risk charge and RNIV measure.

The VAR- and SVAR-based RWA amounts are calculated by applying a multiplier to banks’ own model outputs. If a bank incurs five or more VAR model backtesting exceptions in a 250-day period, which happens when actual trading losses exceed those estimated, the multiplier increases. This ratchet mechanism is intended to punish banks with VAR models that consistently undershoot their true exposures.

However, exceptional market volatility in the first quarter inflicted a host of backtesting exceptions that threatened to push market RWAs to record highs. To prevent automatic multiplier increases from making the regulatory capital burden of trading intolerable, the PRA allowed banks to offset these by deducting the same amount of RWAs from RNIV requirements.

Why it matters

Without the PRA’s intervention, market RWAs at NatWest Group and its UK peers would have soared over the first half of this year, ramping up the regulatory capital costs of trading and maybe forcing a major dealer or two to step back from the market to preserve its solvency ratio.

NatWest has also been winding down its trading operations in recent months. Without the relief, it’s possible the cull would have been faster and deeper as the firm sort to avoid spiralling market risk capital costs.

However, while helpful to the smooth functioning of the financial system as a whole, this regulatory intervention, like others focused on credit risk losses, also complicates effective monitoring of the risks carried by banks through the coronavirus crisis, and makes their disclosures less comparable. 

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