Are You Ready for the New Basel Capital Requirements for Operational Risk?
The Basel Committee on Banking Supervision (BCBS) has finally provided clarity on future minimum capital requirements for operational risk for banks and other firms subject to these changes.
A new standardised approach will replace all previous methods of determining minimum operational risk capital requirements, including the modelled approach known as Advanced Measurement Approach (AMA). The final details share much in common with the previous consultation, issued March 2016, with operational risk capital to be calculated based on a business indicator component and a loss component. Regardless of the overall pros and cons of the changes, the new approach does raise some interesting considerations, which will likely surface during implementation.
- Internal Loss Multiplier (ILM): The use of the ILM is at national discretion and it is not yet clear on what basis this decision will be taken. If jurisdictions take different decisions, operational risk capital requirements will not be comparable across firms. The loss component will likely push up capital requirements for firms that have high levels of historic losses or have undergone significant changes in scale.
- Future of models: The new standards do not allow for modelled approaches to calculate Pillar 1 requirements. Nevertheless, banks will still be expected to estimate their own capital requirements under Pillar 2. By removing the prescriptive requirements of AMA, banks can focus on developing models fit for other purposes.
- Loss data: As loss data will become a direct input, and given enhanced disclosure requirements under the new rules, the quality of internal loss data collection has become even more relevant.
- Impact of insurance: Insurance recoveries should be included in loss datasets. Insurance coverage can therefore directly impact capital requirements for many years through the ILM. Insurance coverage in years prior to implementation will affect minimum capital levels after implementation, and the new approach impacts decisions regarding optimal insurance programmes.
Firms Should Act Now
Although the new changes will not come into effect until 2022, we recommend you begin assessing the impact of the new approach now and taking relevant steps to make sure your firm is ready, including:
- Assessing the impact of the new standards on capital requirements and plan accordingly.
- Determining future strategy for operational risk modelling.
- Reviewing the quality of loss data and loss data collection standards.
- Considering the optimal structure of your insurance programme in light of the new standards.
Knowing how the new requirements will affect your organisation now will help you be prepared for possible challenges as the implementation date draws nearer, with early action likely to have long term benefits.