Fitch Ratings has today published a report which evaluates the key components and drivers of Basel II risk-based capital ratios. The report identifies notable drivers of risk-weighting calculations and provides insight on the comparison of capital ratios across financial institutions.

Basel II is a significant step forward in promoting more meaningful comparison of risk capital globally. At the same time, numerous sources of variability in the calculation of Basel II capital ratios pose analytical challenges in comparing risk capital on a like-for-like basis across banks. Fitch's report examines these potential sources of variability, which include differences in risk estimation and modeling processes, choice of Basel II calculation approaches, asset classification and segmentation, national implementation rules, quality of regulatory capital, and accounting practices. The report also identifies risks that regulatory capital ratios do not address.

"In evaluating risk capital, it is important to consider drivers of enterprise risk, including concentration risk, liquidity risk, and tail risk, which are not explicitly captured by Basel II ratios," said Martin Hansen, Senior Director of Credit Market Research at Fitch.

Fitch's approach to evaluating Basel II ratios is grounded in facilitating comparison across banks.

"Substantively comparing Basel II ratios across banks involves dissecting ratio components and drivers, critically evaluating underlying assumptions within the calculation process, and performing sensitivity analysis where appropriate," said Gordon Scott, Managing Director in Fitch's Financial Institutions group.

In Fitch's view, it is important to reconcile or contextualize capital ratios and other quantitative metrics within a broader analysis of a bank's risk appetite, asset quality, portfolio-level concentrations and credit culture.

Fitch notes that Basel II remains an evolutionary process. Key revisions relating to trading book risks, resecuritisations and treatment of liquidity facilities will be implemented with effect end-2010. In addition, more sweeping proposals announced in December 2009 - dubbed "Basel III" by market participants - are the subject of a consultation process and impact study with a target implementation date of end-2012. These latter proposals relate to definition of components of regulatory capital, the introduction of global leverage and liquidity ratios, higher capital charges for counterparty exposures and the introduction of countercyclical measures. Fitch is evaluating the potential impact of these latest proposals and will provide further commentary in due course.

The full report, entitled "Basel II Capital Ratios: A Field Guide for Assessing Risk-based Capital Basel II", is available on Fitch's website at www.fitchratings.com. The report can be found under the link to Fitch's dedicated 'Basel II' webpage (under 'Market Focus').