(v) Calculating the ARW based on the ARS

For every ARS, the DGS should assign a corresponding ARW by setting the thresholds for the ARW and by applying either the ‘bucket’ or ‘sliding scale’ method, irrespective of the method used to determine the various IRSs of the risk indicators.

The DGS should assign the ARW to the ARS in such a way that it is possible for member institutions to be assigned to the lowest and highest ARW, and for the various risk classes to be populated. In particular, the DGS should avoid calibrating the model in such a way that almost all member institutions, despite having significantly different risk profiles, would be assigned to only one risk class (for example, the risk class for institutions with an average risk profile) and hence assign them the same ARW. However, this does not imply that in each period the DGS should necessarily use the full interval and assign member institutions to the ARW corresponding to the lowest and the highest thresholds of the ARW.

Thresholds for ARW

The DGS should set the upper threshold ‘α’ and lower threshold ‘β’ of the ARW to reflect the differences in risk incurred by different member institutions.

The DGS should set the upper threshold ‘α’ of the ARW between 150% and 200%.

The DGS should set the lower threshold ‘β’ of the ARW between 50% and 75%.

The DGS may set a wider interval upon justification that the interval limited to 50%-200% does not sufficiently reflect the differences in business models and risk profiles of member institutions and that it would create moral hazard by artificially grouping together member institutions with very different risk profiles.

The ‘bucket’ method for the ARW

If the DGS applies the bucket method, it should define ranges for the ARS in such a way that they correspond to a particular risk class (bucket) and assign an ARW to each bucket according to the following formula:

𝐴𝑅𝑊 𝑖 = 𝛽 ∗ ( 𝛼 𝛽 ) ( 𝐵𝑢𝑐𝑘𝑒𝑡 𝑃−1 𝑝 −1 )

Where:

P = the total number of buckets for the ARW;

p = the number of the bucket, starting at 1 (the lowest possible risk bucket) and ending at P (the highest possible risk bucket);

𝛽 = 𝐴𝑅𝑊(1) , i.e., the desired ARW value corresponding to bucket 1 (lower limit); and

𝛼 = 𝐴𝑅𝑊(𝑁) , i.e., the desired ARW value corresponding to bucket P (upper limit).

The DGS should set the number of buckets ‘ P ’ in proportion to the number and variety of member institutions. However, the DGS should set at least four buckets ‘ P ’ . The DGS should set at least one bucket for member institutions with an average risk, at least one bucket for low-risk members and at least two buckets for high-risk institutions. The ‘sliding scale’ method for the ARW

If the DGS applies the sliding scale method, it should assign each ARS a corresponding ARW according to the following formula: