Operational risks will rise as banks increasingly rely on technology, heightening exposure to systems failure and cyber attacks. Banks also face growing compliance and regulatory risks and the overhang of unresolved litigation is still considerable in some markets.
According to Fitch Ratings, the Basel Committee’s proposed overhaul of the way banks calculate how much capital they need to cover operational risk should result in simpler, more standardised charges, allowing for greater comparability.
Banks have been calculating operational risk capital requirements for over 10 years since the implementation of Basel II, but in many cases capital set aside proved inadequate to cover substantial losses arising from misconduct fines, controls failure or fraud, for example.
The Basel Committee’s update on post-crisis reforms, presented to the G20 leaders at the recent Antalya summit, confirms that it is considering eliminating the use of internal models to calculate operational risk capital charges. Basel II introduced several methods for calculating operational risks to reflect particular risk profiles across banks, variations in operating environment and management practices. But we believe flexibility has confused market participants and contributed to a lack of transparency.
The Basel Committee is considering replacing all current approaches with a single new standardised measurement approach (SMA), and will open a one-year consultation period by end-2015. SMA will borrow from the current advanced measurement approach (AMA) by incorporating a requirement for banks to continue to collect operational risk loss data, but internal modelling will not be used to determine appropriate capital levels. Comparing operational risk capital charges currently set aside by banks using AMA has proved difficult, largely because internal models are highly complex, methodologies vary from bank to bank and calculation outputs lack transparency.
Some Basel II methods for calculating operational risk charges are predetermined by regulators, such as the basic indicator and standardised approaches, both of which link capital charges to gross income (the standardised approach allows banks to vary multipliers across business lines and units). But operational risk capital charges can also be calculated using an internal measurement approach where banks draw on data from their internal operational loss experiences. The Basel Committee, which is already driving a trend to reduce reliance on complex models in other areas, says it will consult on removing the AMA. The AMA gave banks the greatest amount of freedom to set operational risk charges, as flexibility on the modelling approach meant risk charges would differ even when applied to the same base data.
