The acid test of whether these empirical and theoretical concerns about risk-weighting have merit comes from assessing the evidence. Do risk weights help in signalling bank failure? There have been a number of recent studies comparing the predictive performance of Basel risk-based capital ratios and simple leverage ratios for bank failure. The results are both striking and surprising. Studies by IMF (2009), Demirguc-Kunt et al (2010), Haldane and Madouros (2012), Mayes and Stremmel (2012), Brealey et al (2011), Berger and Bouwman (2013), Blundell-Wignall and Roulet (2013) and Hogan et al (2013) perform a horse-race between different bank solvency measures, using a variety of techniques, samples and controls. Despite these differences, the conclusion they draw is broadly consistent: leverage ratios perform as well, and in most cases better, than risk-weighted alternatives in predicting bank failure. These results appear to be stronger for large banks, often using internal models, than for smaller banks typically using standardised approaches (Haldane and Madouros (2012)). This is not altogether surprising given that model risk is largest among banks making greatest use of models and with the largest portfolios. It is also the case that no measure of bank capital adequacy, by itself, provides a full-proof forecast of impending bank failure: the predictive power of all solvency metrics, leverage or otherwise, is fairly low. BIS central bankers’ speeches  5  Nonetheless, these results send a sobering message. Even on risk-sensitivity grounds, riskbased capital measures may often be trumped by risk-insensitive alternatives. The noise in risk weights may be drowning-out the signal.
At the same time, unemployment in the euro area remains high, and the necessary balance sheet adjustments in the public and the private sector will continue to weigh on economic activity. This assessment is also reflected in the December 2013 Eurosystem staff macroeconomic projections for the euro area, which foresee annual real GDP declining by 0.4% in 2013 before increasing by 1.1% in 2014 and 1.5% in 2015. Compared with the September 2013 ECB staff macroeconomic projections, the projection for real GDP growth for 2013 has remained unchanged and it has been revised upwards by 0.1 percentage point for 2014. The risks surrounding the economic outlook for the euro area are assessed to be on the downside. Developments in global money and financial market conditions and related uncertainties may have the potential to negatively affect economic conditions. Other downside risks include higher commodity prices, weaker than expected domestic demand and export growth, and slow or insufficient implementation of structural reforms in euro area countries. BIS central bankers’ speeches  1  According to Eurostat’s flash estimate, euro area annual HICP inflation increased in November 2013 to 0.9%, from 0.7% in October. The increase was broadly as expected and reflected, in particular, an upward base effect in energy prices and higher services price inflation. On the basis of prevailing futures prices for energy, annual inflation rates are expected to remain at around current levels in the coming months. Over the medium term, underlying price pressures in the euro area are expected to remain subdued.