Smart by Design, or Flaw in the Design?
- Danny Dieleman
- 5 days ago
- 13 min read
Why the same private credit loan is different on a bank’s or insurer’s balance sheet
Introduction
Since I started exploring partnerships between banks and insurers, I have been intrigued by the question: “how can a loan, with a certain economic risk profile, have a very different capital charge on a bank’s or an insurer’s balance sheet, and is this capital arbitrage, or not?”
Over the years, I have had many discussions with colleagues on this topic and more recently, I have received reactions and questions on my posts about the cooperation between banks and insurers: how-smart-structuring-helps-banks-and-insurers-maximize-regaultry-benefits. Apparently, it is a topic that more people relate to.
The question is certainly more relevant than ever, with the rise in Private Credit, where Insurers and Alternative Investment Managers are stepping into lending activities by providing loans to borrowers. See also my previous post, together with Anand Autar: the-great-migration-capital-arbitrage,-disintermediation-and-the-future-of-intermediation
So, I decided to delve a bit deeper into the subject and do some research on this topic. In this article I will summarize some of the data that I have been gathering, and I will also try to find answers to the questions above.
Same Assets, Different Rules?
Let’s start with a Commercial Real Estate (CRE) Loan as an example and compare the capital charges for credit risk for banks and insurers. Suppose the value of the property is €200mn and the loan amounts to €110mn and loan has a maturity of 5 years, with quarterly repayments of €1.1mn and a margin of 175bps. At the start of the loan, the LTV is 55%, and the duration is 4.38 years.
On the balance sheet of a bank it falls under the CRR rules. Assuming the bank is on the Standardized Approach, then the primary driver of the amount of capital that the bank must hold is the Loan to Value (LTV). The type of real estate, the location, the maturity of the loan, any repayments are not explicitly considered as drivers of the capital charge. The Risk Weighted Assets for this loan are 70% and the capital charge is then 5.6%, assuming an 8% CET-1 ratio.
The same CRE loan, when held on the balance sheet of an insurer has completely different drivers for the capital charge. Obviously, LTV is an important driver, but also duration is a driver of the capital charge. Under Solvency II, the capital charge for the credit risk of this loan amounts to 6.57%. However, under Solvency II, explicit benefit is given to diversification benefits when aggregating capital charges of individual risks. When allocating these diversification benefits back to the transaction, the capital charge can be in the range of 4% till 5%. Diversification will be further discussed later in this post.
The example clearly shows that the capital charges for the same loan differ for banks and insurers. The following sections will delve deeper into the differences in business models, balance sheet structure, expected loss and capital regulations between banks and insurers.
Two Industries, Two Worlds: Different Balance Sheets
Banks and insurers are both financial institutions, but they have two very different businesses models. Banks generate their profits by intermediating between parties that have a surplus of savings and parties that have a need for financing. Their profit comes from the difference in interest rates that they charge to borrowers and the interest they pay on the deposits.
Insurers, on the other hand, collect premiums from policy holders to provide protection against risks, like property damage, ill-health and death. These premiums are invested to provide returns to cover for future claims.
These different business models are reflected in the different compositions of the balance sheet and the risk profile of banks and insurers. This section will examine some key differences in the balance sheet structures of five large banks and five large insurers from the Euro-area. The main focus will be on the liabilities with a comparison of total balance sheet size, leverage ratio and the duration of the liabilities.
Note that there are always caveats when comparing different types of companies with each other on the basis of annual reports. Although IFRS harmonizes to a large extend accounting definitions, institutions have still some flexibility in the presentation of the numbers, making a like for like comparison not always straightforward. It is, however, very well possible to draw conclusions from it.
Table 1 below shows the statistics for five large European banks and five large European insurers. The data have been obtained from the 2024 annual reports, the Pillar III bank disclosures, and the Solvency and Financial Conditions Reports for insurers.
The table shows clearly that the size of the largest European banks exceeds the size of the largest European insurers. This is an important difference, as banks tend to become more systemic with size, while insures benefit from more diversification when their size increases.
A second indicator to look at is the leverage ratio. The leverage ratio is defined as equity / balance sheet total. This ratio decreases with increasing leverage. For banks, leverage can be calculated relatively straightforwardly. For Insurers, however, this is less simple, as insurance liabilities are based on estimates of future claims, for which quite some modeling is involved. Therefore two types of leverage are shown in the table. The first one is a simple IFRS 9 leverage, based on the consolidated balance sheet and expressed as equity / balance sheet total. Secondly, for banks the leverage as reported under the CRR is shown and for insurers, the leverage based on the Market Value of assets and liabilities is shown. Both measures for leverage show that banks operate with a leverage ratio that is twice, or three times as high as the leverage ratio of insurers.
The third measure shown in the table is the weighted average time, or Macaulay duration, of the client deposits for banks, and the duration of the insurance contracts for insurers. This is not the same as the duration of the total liabilities, as both banks and insurers have, next to their client business, also issued bonds, as well as derivatives portfolios, which alter the duration of the total balance sheet.
The short-term nature of the liabilities of banks leads to another big difference between banks and insurers: bank runs. Bank clients can instantly withdraw their cash in case of loss of confidence, or rumors. Famous are the bank runs during the Great Depression in the 1930s, but also more recent examples of Northern Rock in the UK in 2007, or Silicon Valley Bank in 2023, show that bank runs can still happen. A recent study of the ECB showed that a significant portion of the deposits can be withdrawn over a period of days or weeks. This is illustrated in Figure 1.
Whereas banks are primarily funded with short-term deposits that can be withdrawn overnight, insurers have illiquid liabilities, that cannot be withdrawn. So, for insurers there is no equivalent of a bank run. The policies of an insurer may be surrendered by their customers, or the insurer may be subject to mass claims by its customers, but this does not lead to overnight liquidity issues. In the Netherlands, for example, insurers face mass claims from savings-linked mortgages with excessive administration fees that were not invested in the clients account. The first concerns arose in 2006, with regulators stepping in since 2015. The process is still ongoing at the moment, with some claims only recently being settled. This can hardly be called a “run”.
Another difference, but more difficult to measure with publicly available data is the difference in interconnectedness. Banks are lending to each other via the interbank market and therefore exposed to contagion in case of bank defaults, or bank stress. Insurers, on the other hand, have shared exposures on both the asset, as well as liability side of their balance sheet, but have limited exposure to other insurers for liquidity. An exception here is the interconnection through re-insurance, as a single re-insurer may cover the same risks across different insurers. This may cause concentration risks at the re-insurer level that may bounce back and affect individual insurers in case of stress.
Regulation Follows Business Model
As shown above, the business models, the risk profiles and the balance sheet composition for banks and insurers are very different. It therefore should not come as a surprise that their prudential frameworks are different as well. Since the start of 2025, banks are subject to CRR III, which is based on the Basel III framework, also referred to as Basel IV amongst bankers. European insurers are subject to Solvency II, which came in effect in 2016.
Since the subject of this article is the capital arbitrage of illiquid loans, the focus will be on the capital charges for credit risk of corporate loans under the Standardized Approaches of CRR and Solvency II. To keep the article not too long only the most relevant elements will be compared. Note that both banks and insurers have the possibility to (partially) use internal models.
Banks
The standardized approach for loans is relatively straightforward and primarily focuses on capturing default risk. Under this approach, a risk weight is assigned to each loan based on the type of borrower. While this risk weight may incorporate external credit ratings, it does not consider factors such as the borrower's country of residence, industry sector, loan maturity, repayment structure, or the level of available collateral.
To calculate the capital requirement, the risk weight is applied to the total exposure of the loan. This risk-weighted exposure is then compared against the bank’s available capital. For the purpose of comparing CRR III and Solvency II in this article, an 8% capital requirement will be assumed.
It is important to note that these credit risk weights reflect potential losses from borrower defaults. They do not capture fluctuations in market value, as bank loans are typically measured at amortized cost.
Insurers
Solvency II requires insurers to value both assets and liabilities on a market-consistent basis. This means that valuations should reflect current market conditions, rather than historical cost or book values.
When it comes to loans, the capital charges under Solvency II are designed to capture both default risk and market value volatility. These requirements are outlined in the spread risk sub-module of the market risk module (which will be discussed in more detail later in the article). Under the Standard Formula, capital charges are primarily driven by the external credit rating of the loan and its maturity. In certain cases, the Standard Formula also allows for recognition of collateral.
Figure 2 shows for both banks and insurers the capital charges for corporate loans with an external rating. The graph shows that the capital charges for banks are independent of duration, while for insurers the capital charge increases more or less linearly with duration. During the first 1.5 or 2 years, the capital charges for insurers are lower than the the capital charges for banks, after which this pattern reverses and the capital charge for the insurer exceeds the capital charge for banks.
At first glance this looks counterintuitive, since insurers need long-dated assets to match their liabilities. However, the framework also recognizes that not all spread volatility is economically relevant. Through adjustments in the liability discount rate, the impact of short-term market movements on capital is dampened. Most commonly used in the EU is the volatility adjustment, which reduces the value of liabilities in times of market stress. This improves the insurer’s solvency position when spreads widen, offsetting part of the higher capital charges on long-dated loans.
The calculation above does not consider the effects of the volatility adjustment. It also doesn’t cover diversification, which can also have a substantial impact. Diversification is the topic of the following section.
Diversification
Under the Basel credit risk framework, as adopted in CRR III, diversification is implicitly assumed. This is evident in the advanced approach for banks, which relies on complex capital formulas that incorporate a correlation factor ρ. This correlation factor influences the capital requirement for individual loans and is a function of the probability of default (PD). Specifically, exposures with a lower PD are assigned a higher correlation and thus lower diversification. For those interested in the technical details, Figure 3 illustrates the Basel credit risk formula, including the correlation component.
Capital requirements are first calculated at the individual transaction level. The total capital required at the portfolio level is then determined by summing the capital charges of all loans in the portfolio—without any further adjustments for diversification effects.
Additionally, no diversification across different risk categories—credit, market, or operational risk—is recognized under Pillar I. Banks may consider such diversification effects under Pillar II.
Solvency II, however, explicitly models diversification benefits between risk types. The Solvency II framework is divided into several (sub)-modules, see Figure 4. Each sub-module considers a certain risk type and prescribes how the capital charge for this risk needs to be calculated. When aggregating the capital charges to the total level, diversification is factored in by correlation matrices. In the Standardized approach, these diversification matrices are prescribed.
As an example, Figure 5 shows the prescribed correlation matrix of the market risk module. Note that the correlation factors deviate from 1, allowing for substantial diversification. The application of correlation matrices has a significant impact on the total level of capital that an insurer needs to hold. The picture below illustrates this for Nationale Nederlanden (NN). Please note that NN partially uses Internal Models. The waterfall, however, still shows clearly that diversification lowers the total amount of capital that NN needs to hold for its market risk by as much as 33%. A similar aggregation holds when aggregating the individual modules, like market, Health, Life and Non-life risk to total institution level. For NN this leads to another 27% of diversification benefit, when aggregating to total portfolio level.
Allocation of the diversification benefits back to the individual sub-modules and risk types, will lower the capital at risk-level as well. This will lower the capital charges as shown in Figure 2 for Insurers considerably by about 30% - 40%. This brings the capital charge for insurers below that of banks until maturities of about 3 till 4 years. Just to reiterate, this analysis does not take into account the Volatility Adjustment that dampens the effect of credit spread movements.
Arbitrage or Architecture?
The previous sections showed that the business models and balance sheets of insurers and banks differ and therefore their capital frameworks are different. This section focusses on the main question in this article: is this regulatory failure, or does this reflect institutional design?
For banks, the Expected Credit Loss (ECL) of an individual loan is primarily reflected in Loan Loss Provisions (LLP), which are mainly based on default risk. As the credit quality of a loan deteriorates, the LLP increases, leading to a reduction in the bank’s equity and available capital. In contrast, insurers capture the ECL of a loan through its Fair Value or Mark-to-Market valuation. When credit quality declines, the Fair Value of the loan decreases accordingly, directly reducing the insurer’s equity.
Thus, both LLPs (for banks) and Fair Value adjustments (for insurers) will reduce the capital base. Provided that the valuation and provisioning models are properly calibrated, the economic impact at the individual asset level should be comparable for both types of institutions. Moreover, in the unfortunate event of a default and full write-off, both the bank and the insurer will recognize the same loss, assuming the loan was initially valued at 100%. As a result, there is no arbitrage at the single-loan level.
Capital serves as a buffer against unlikely but severe losses and is held at the institutional or portfolio level. It is therefore subject to portfolio effects, including diversification benefits and the interaction between assets and liabilities. Importantly, the loss-absorbing capacity of liabilities plays a key role in determining how much capital is required at the institutional level.
Because the nature of liabilities differs fundamentally between banks and insurers, the role and effectiveness of capital buffers also differ. Even if the same loan is held by a bank and an insurer, the expected loss at the individual loan level may be identical, but the capital held against it at the institution level can justifiably vary.
Banks hold capital primarily to protect depositors from insolvency. Their capital acts as a buffer not only against credit risk, but also against market, operational, and liquidity risks. In addition to capital, banks are required to maintain a stock of high-quality liquid assets to manage short-term liquidity stress.
Insurers, by contrast, hold capital to protect policyholders, often over much longer time horizons. Their capital is structured to absorb long-term liability risks and the market risks associated with their investment portfolios. Because their liabilities are typically more stable and predictable, insurers can absorb certain shocks differently than banks.
As a result, the capital requirements for the same underlying asset may differ between banks and insurers, which is thus both logical and justifiable when considered in a broader institutional context.
Closing Thoughts
Despite the methodological differences, both CRR III and Solvency II frameworks aim to ensure that institutions remain solvent and capable of absorbing losses. The mechanisms, LLPs and capital charges for banks, versus fair value adjustments and SCR for insurers, may differ in timing and approach, but both ultimately serve to reduce the capital base when credit quality deteriorates.
Furthermore, if both banks and insurers use properly calibrated models that reflect realistic loss expectations and economic risks, the impact of credit deterioration on their capital positions should be broadly comparable at the individual asset level. As such, the existence of different capital requirements across sectors does not constitute a regulatory arbitrage opportunity, but rather reflects different roles, accounting treatments, and supervisory priorities.
When structured appropriately, the difference in capital treatment between banks and insurers does not constitute regulatory arbitrage. Rather, it reflects sound regulatory design tailored to the specific roles, business models, and risk profiles of each type of institution. Regulatory arbitrage arises only when transactions are deliberately structured to exploit differences in regulation in order to achieve lower capital charges without a corresponding reduction in underlying risk.
Since this reflects architecture, rather than arbitrage, financial leaders should focus on strategical considerations like:
Who is the optimal holder of a particular loan? Long dated, cash flow stable loans, such as project finance, or infrastructure loans, better fit insurers, due to their long liabilities and investment horizon. In contrast, revolving credit and working capital facilities fit better with the business model of a bank.
How can a facility be optimally structured to benefit all stakeholders? By smart structuring the strengths of both banks and insurers can be combined to provide optimal flexibility and competitive financing for borrowers. One can think here of different tranches, tailored maturities, and credit enhancement to suit the capital and liquidity requirements of banks and insurers.
What is the appetite of an insurer to invest in illiquid loans, and how does it fit in its overall asset mix? Although insurers have long-term illiquid liabilities, they need to carefully consider their risk tolerance, liquidity needs and capital requirement. Especially during stress scenarios, as this may put pressure on their balance sheet and profitability.
Does the insurance company possess the right capabilities to structure, underwrite and manage the loan across the entire lifecycle? This includes, amongst others, monitoring of the credit performance, or possible refinancing risk. But also, a possible workout in case of a default situation. If the insurance company does not have these capabilities, they should either be developed, or it will need to rely on an external asset manager.
So, ultimately, aligning capital with the right institutional holder can lead to synergies in a partnership between banks and insurers and the differences in capital treatment can be put at work to structure partnerships that serve the real economy.
About the Author
Danny Dieleman
is a seasoned financial professional with over two decades of experience in risk management, balance sheet optimization, and financial strategy. Drawing on a PhD in Physics and a background as a lecturer at the University of Amsterdam, he combines analytical depth with practical execution—turning complex financial and capital challenges into clear, strategic solutions. Currently serving as Senior Treasury Executive at a Leading European Bank , he’s passionate about innovation, collaboration, and building smarter ways to understand and deploy risk and capital.
Follow Danny Dieleman on his blog at https://substack.com/@dannydieleman
The views expressed are his own and do not represent the views of his current or former organisations.
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