Value Partners, a leading management consultancy firm in the Middle East, said it has identified strategies for banks in the Gulf region to help them reduce the risk weighted assets (RWA) and optimise capital.

The company stressed on the importance of debt collateralisation, product switch and improving client credit rating to reduce RWA and optimize invested capital.

“Reduction of risk weighted assets provides an opportunity to free invested capital and re-allocate to fresh lending especially when capital is a constraint and short-term results are needed,” remarked Roland Topic, senior manager of Value Partners.

Highlighting the areas of RWA optimization, Topic said, "Effective credit risk management can be used as a key strategy to optimize invested capital."

Value Partners assessed that the implementation of Basel II norms, as well as the minimum capital adequacy norms of 12 per cent had put pressure on the banks’ capital management and risk management strategy.

"As the banks in GCC implement Basel II regulations, competition increases and pressure on profit margin mounts, the need for effective implementation of a RWA strategy becomes critical," he pointed out.

"In a period when the banking sector is facing economic challenges, which can cause constraints on raising new capital, banking institutions can create value for their stakeholders by enhancing their risk management strategy and generate short and long term competitive advantage," Topic added.

Value Partners pointed out that the three key areas of risks were credit, market and operational.

"Credit risk, being the foremost, affects typical banking assets - mortgage, loans and the like. Basel II allows banks to calculate its risk weighted assets either using the standardized approach or based on the bank’s internal ratings based (IRB) approach.

“The IRB approach is more complicated to implement than the standardized approach. However, in the case of most large banks, it is an accurate measurement of the risk in its portfolio, making it a necessity in the long run,”noted Topic.

Based on its previous experience with large banks in Europe and the Middle East, Value Partners recommends working on three levers that can be utilised to launch an effective RWA reduction program.

"First is focusing on collateralization of debt or increasing the value of collateral as it reduces the loss in case of default due to a higher rate of recovery. The second is switching products and amending product features to lower RWA products, as banking products have different rules and criteria in terms of risk weights," he explained.

"And third is to support clients in improving their credit rating that reduces the probability of default and consequently the RWA," he added.

For best results, Topic stated, a combination of these three courses of action has to be carefully pursued. "They require limited IT intervention and generate capital that can be reinvested through the network of branches by aligning incentive schemes, management objectives and measurement metrics."

"In a recent experience with large European bank, we discovered that a product switch from invoice discounting to factoring provides a 40 per cent capital benefit."

According to Value Partners, RWA reduction allows managers of GCC banks to optimize capital utilization that generates value for the bank at minimum cost.

“However, banks should avoid the risk of revenues decreasing due to the expansion of lower risk products that are usually lower priced and should balance the trade-off between maximizing revenues and reducing RWA, pursuing a point of equilibrium between the two,” Topic added.-TradeArabia News Service