Monday, March 7, 2016

Basel Consults on Overhaul of Operational Risk Management

New Framework May Raise Overall Capital Requirements for Some Banks

Author: David Schwartz J.D. CPA

On March 4, 2016, the Basel Committee issued a consultation paper on the standardised measurement approach for operational risk. The newly proposed framework, dubbed the “single measurement approach” (SMA) for risk assessment, addresses weaknesses BIS has identified in the existing framework, which the consultation document describes as “unduly complex.” 


According to BIS, the complexity of the three methods used in the existing framework has resulted in “excessive variability in risk-weighted assets and insufficient levels of capital for some banks.”  The new approach, the SMA, seeks to remedy the variability of the old methods by requiring large banks to use a combination of a “Business Indicator,” a simple financial statement proxy of operational-risk exposure, with bank-specific operational loss data, combined with loss history to calculate operational risk.  The use of financial statement information and banks' internal loss experience will, according to BIS, improve consistency and comparability in operational risk capital measurement.


The proposal removes the option to use the internal model-based approach, the "Advanced Measurement Approaches" (AMA), from the framework entirely.  The Committee reasoned that modelling of operational risk for regulatory capital purposes is unduly complex and that the AMA allows too much variability in estimates of risk-weighted assets, sometimes resulting in the reservarion of insufficient levels of capital for some banks.


Stefan Ingves, Chairman of the Basel Committee on Banking Supervision and Governor of Sveriges Riksbank, remarked that “the proposals are an important step towards completing the post-crisis reforms during the current year.”   He noted the Committee's plans to conduct a quantitative impact study (QIS) to help inform the final calibration of the proposed standard and added: "For most banks, the Committee expects that these proposals will have a relatively neutral impact on capital. While the objective of these proposals is not to significantly increase overall capital requirements, it is inevitable that minimum capital requirements will increase for some banks."


Comments on the proposals are due by Friday June 3, 2016.