Basel committee consults on standardised measurement approach for operational risk capital

The Basel Committee on Banking Standards has launched its much-awaitedconsultation paper on proposed revisions to the operational risk capital framework.

It lays out plans for the new standardised measurement approach (SMA) to replace the advanced measurement approach (AMA), which currently allows banks to dictate their own capital requirements for operational risk. Three other existing models are also to be removed under the proposals.

The Committee says the thinking behind the change is to simplify the regulatory framework for operational risk capital. The new methodology combines “a financial statement-based measure of operational risk” known as the business indicator, with the individual firm's past operational losses. It’s hoped this will create a more risk-sensitive framework and more consistency across the industry.

The AMA approach has received criticism over the years for being over-complex and for producing inconsistency between different institutions. The Basel Committee says allowing banks to tailor their approach to operational risk also resulted in insufficient capital being put aside for this purpose in some cases. The AMA model is currently used by about 70 of the world’s largest banks such as Deutsche Bank, UBS and Citigroup.

“The proposals are an important step towards completing the post-crisis reforms during the current year,” said Stefan Ingves, chairman of the Basel Committee and governor of Sveriges Riksbank. He noted the Committee's plans to conduct a quantitative impact study to help inform the final standard and downplayed the impact the change would have on firms. “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,” he said.

The Committee says all banks should still comply with the Committee’s Principles for the sound management of operational risk which was published in 2011 and outlines industry best practice in governance, risk management and disclosure.

Capital calculation under the SMA relies heavily on internal loss event data, so the new proposals outline key requirements for banks when identifying and collecting this information, including a 10-year minimum observation period (five years when first moving over to SMA) and a documented process for loss data cultivation. “A bank’s internal loss data must be comprehensive and capture all material activities and exposures from all appropriate subsystems and geographic locations,” it says. There are also detailed requirements for recording operational risk events, including the date when the event happened or first began; the date on which the bank became aware of the event and “the date when a loss, reserve or provision against a loss was first recognised in the bank’s profit and loss accounts.”

The consultation closes on Friday 3 June, 2016. Click here for the full paper:

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