Wells Fargo and Bank of America Show Largest Internal vs. Regulator Model Gap

Wells Fargo and Bank of America exhibit the largest discrepancies between their internal risk models and regulator-set standardized models, according to data from Risk Quantum. This gap affects how systemic banks calculate risk-weighted assets (RWAs), which directly determines the amount of capital they must hold to meet regulatory adequacy requirements.

The analysis shows that modeled RWAs at systemic banks undershoot standardized calculations by a total of $441 billion. This difference reflects the variance between the internal models banks develop to assess their own risk and the standardized approaches mandated by regulators like the Federal Reserve.

Impact of the Capital Floor on Systemic Banks

Regulators use a “capital floor” to limit the extent to which banks can use internal models to lower their capital requirements. This mechanism ensures that RWAs do not fall below a specific percentage of the amount calculated using standardized methods. When the gap between internal and standardized models is wide, banks face a higher likelihood of needing to increase their capital buffers to comply with the floor.

The $441 billion shortfall identified by Risk Quantum indicates that several major institutions have been reporting significantly lower risk levels than the standardized formulas would suggest. This creates a potential volatility risk if regulatory shifts force a rapid transition toward the Expanded Risk-Based Approach (ERBA) or other standardized frameworks.

RWA Discrepancies Across Major Institutions

The data highlights a tiered landscape of risk modeling among the largest U.S. and global banks. While Wells Fargo and Bank of America show the most significant gaps, other systemic players also maintain variances between their internal assessments and the regulator’s benchmarks.

• Wells Fargo and Bank of America: Identified as having the largest gaps between internal and regulator-set models.
• Other Systemic Banks: Institutions including JP Morgan, Citi, Morgan Stanley, and State Street are also subject to these comparisons between internal models and standardized approaches.

These discrepancies typically emerge in the calculation of market risk and credit risk. Internal models often allow banks to account for specific mitigating factors or historical data that standardized models ignore, resulting in lower RWAs and a reduced requirement for set-aside capital.

Standardized Approaches vs. Internal Models

The tension between internal and standardized models is a central component of the Basel III endgame and subsequent regulatory updates. The Federal Reserve and other global regulators have pushed for greater consistency across the banking sector to prevent “model arbitrage,” where banks might optimize internal models to artificially lower their capital requirements.

The Expanded Risk-Based Approach (ERBA) is designed to provide a more granular but still standardized method of calculating risk. By reducing the reliance on internal models, regulators aim to create a more transparent and comparable set of capital adequacy ratios across the global systemic banking network.

For banks like Wells Fargo and Bank of America, a narrow gap between these two methods would signal that their internal risk perceptions align with regulatory expectations. The current $441 billion aggregate undershoot suggests that internal models remain significantly more optimistic about risk exposure than the standardized frameworks used by the Federal Reserve.