30/01/2016

RWA Density | What Lies Behind This Underrated Financial Ratio (January, 2016) by Léonard BRIE & Hélène FREON

The objective of this article is to provide a new angle to the study of RWA density. The worth of this ratio, created and largely used by financial analysts, has long been underestimated by banks. Yet as analyses show, this tool may enable a more subtle approach to risk appraisal within a financial institution.

The first part of this article will cover the origins of the ratio and the history of its use in financial analysis. The second part will showcase its characteristics and behavioural traits (including during stressperiods), exemplified through a number of theoretical tests. It will be followed by a cross-analysis of  the ratio with other indicators that will help underline the informative and predictive value of RWA density.

Finally, the last two parts of the article will putthe theoretical value of RWA density to the test, by conducting a practical analysis of its behaviour in Europe over the 2012-2014 period.

The conclusion will appraise the usage and evolution needed to improve and refine the ratio, in order to monitor scarce resources.

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