Denny Gulino writes on recent research commissioned by Treasury Department’s Office of Financial Research (“OFR”) to investigate the validity of using risk-weightings to determine bank capital requirements:
On risk weighting, OFR commissioned researchers Paul Glasserman at Columbia University and Wanmo Kang of the Korea Advanced Institute of Science and Technology to examine the subject from the ground up. As much as the practice has been incorporated in regulatory parlance, they were able to find very little other research on the validity of the weighting methodology.
“Risk weights implicitly assign prices in terms of additional capital to asset categories and thus inevitably create incentives for banks to choose some assets over others,” they wrote.
“Surprisingly,” they went on, “the ideal risk weights turn out to have little to do with risk and are instead proportional to the profitability on each asset.”
Read more at Bank Watch: US Tsy's OFR Finds Risk Weighting Has No Clothes | MNI.