1.11 The global financial crisis revealed significant shortcomings in the pre-crisis regulatory framework, particularly with respect to the calculation of risk-weighted capital ratios. Investors lost confidence in capital ratios that were calculated in accordance with earlier iterations of the Basel standards, known as Basel I and Basel II.

1.12 In December 2017, the BCBS also noted that its own empirical analysis showed a 'worrying degree of variability' in the calculation of risk weights at the peak of the crisis. Importantly, variability in RWAs also makes firms' capital ratios less consistent and comparable. While some variability is to be expected in RWAs calculated using IMs, a high degree of variability undermines confidence in capital ratios, and; therefore, confidence in the resilience of firms. Chart 1 shows the BCBS's July 2013 analysis of risk weight variation on firms' capital ratios. It shows the results of a portfolio benchmarking exercise (a hypothetical portfolio exercise (HPE) ), under which 32 large internationally active banking groups were asked to 'evaluate the risk of a common set of (largely low-default) wholesale obligors and exposures'. [The use of a common set of exposures was intended to largely eliminate differences in risk between firms, so that remaining variation would be due to differences in firms' models and in supervisory practices.] The HPE revealed 'notable dispersion in the estimates of PD and LGD assigned to the same exposures'. Similar HPEs focused on market risk in the trading book found similarly high levels of variation.

Chart 1: Impact of Risk Weight variation on capital ratios