WASHINGTON - Nearly a year after the Basel Committee revealed that it intended to make banks hold capital against operational risks, international regulators have released the first detailed look at how the new rules might shape up.
Guidelines issued Dec. 20 by the Basel Committee on Banking Supervision outline how banks should identify, measure, monitor, and control operational risks - of system failure, natural disasters, employee fraud, and other events that can disrupt or damage their business.
Regulators also defined their role in operational risk management and laid out the public disclosures necessary to keep the market apprised of a bank's exposure to such.
"We've described the key elements that the Basel Committee will be looking for in a sound operational risk management approach," said one of the paper's authors, Stefan Walter, who is a vice president in the bank supervision group of the Federal Reserve Bank of New York.
The guidelines came almost a full year after the committee said that it intended to require banks to hold capital against operational risks. In a widely unpopular move, it decided to make banks include a charge for such risks when figuring the amount of capital they need. The calculation of regulatory capital is often referred to as the first of three "pillars" the regulators plan to use to ensure that the global banking system remains safe and sound. The other two are adequate regulation and proper disclosures to investors.
Over the past year the committee has issued a number of papers describing increasingly complex methods of credit risk management that banks can use to help set regulatory capital, if they can demonstrate that their systems are sophisticated enough. Significantly, the committee turned away from an earlier, almost exclusive emphasis on quantitative historic data and now favors a more qualitative, judgment-driven approach.
"To get to the objective of a robust measurement system, banks are moving towards a process of triangulation that includes assessing internal and relevant external data, scenario analyses generated at the business centers, and certain qualitative information that is more forward looking," Mr. Walter said. "Bringing these together within a disciplined structure is what we are seeing as emerging industry best practice for measuring economic capital for operational risk."
He said that the paper represents the evolution of the Basel Committee's thinking. Early discussions concentrated on the use of data, such as loss records, but critics found the results too backward looking to be truly useful. The new focus involves more qualitative information and more judgment on the part of bankers.
The 12-page set of guidelines on operational risk management is the first indication of what the committee considers a satisfactory approach, and a bank's ability to comply will affect the type of measurement that system regulators allow it to apply to other risks.
The guidelines say that banks should have a system in place to measure operational risks posed by its products and business lines, and that they should assess the risks posed by new initiatives before implementing them. They should also have a system in place to minimize risk once it has been identified.
Banks are also encouraged to get their boards of directors to support a dedicated operational risk management program. Senior managers should be responsible for it, and reporting lines should be structured to keep them and board members aware of how it is functioning.
In addition to the guidelines for banks, the committee included 11 pages of guidance for bank supervisors, drawing heavily on discussions with large, complex banks to determine best practices among international institutions.
"We will be tying this to approaches banks can use in their Pillar 1 assessments of regulatory capital," Mr. Walter said.
Pamela Martin, a spokeswoman for Philadelphia-based RMA, the risk management association, praised the guidelines but criticized the committee for not addressing banks' objection to factoring operational risk into the regulatory capital charge.
"The language in the paper recognizes that this is an emerging practice within the industry," she said. "I think it is good guidance to systems and practices that should be in place to manage operational risk - and to the supervisors as to what they should expect from banks."
Ms. Martin said the industry continues to believe that operational risk is better suited to the Basel Committee's Pillar 2, where it would not carry an automatic capital charge but would be left to the judgment of bank examiners.
"Operational risk needs to be addressed more as a Pillar 2 issue than a flat capital charge, and while they do not acknowledge that in this paper, they are at least laying the ground rules for what the supervisors have to look at," she said.
The Basel Committee set a deadline of March 31 for comments.
Related Content Online
