06 October 2014

Bank for International Settlements: Operational risk - Revisions to the simpler approaches - consultative document

In the wake of the financial crisis, the Basel Committee on Banking Supervision has been reviewing the adequacy of the capital framework. The aim is not only to address the weaknesses that were revealed during the crisis, but also to reflect the experience gained with implementation of the operational risk framework since 2004.

At that time, the Committee made clear that it intended to revisit the framework when more data became available. Despite an increase in the number and severity of operational risk events during and after the financial crisis, capital requirements for operational risk have remained stable or even fallen for the standardised approaches. This indicates that the existing set of simple approaches for operational risk – the Basic Indicator Approach (BIA) and the Standardised Approach (TSA), including its variant the Alternative Standardised Approach (ASA) – do not correctly estimate the operational risk capital requirements of a wide spectrum of banks.

The weaknesses of these simpler approaches stem mainly from the use of Gross Income (GI) as a proxy indicator for operational risk exposure, based on the assumption that banks’ operational risk exposure increases linearly in proportion to revenue. This assumption usually turns out to be invalid. In particular, where a bank experiences a decline in its GI due to systemic or bank-specific events including those involving operational risk losses, its operational risk capital falls when it should be increasing.

Moreover, the existing approaches do not take into account the fact that the relationship between the size and the operational risk of a bank does not remain constant or that operational risk exposure increases with a bank’s size in a non-linear fashion. In addition, the changing operational risk profiles of banks may render a calibration based on the past behaviour of variables unfit for the future. Proxy-based indicators used in the operational risk approaches and the calibration of the associated parameters should therefore be periodically tested to ensure their continued validity. Such a review is all the more important given the lack of relevant operational risk data and experience in operational risk modelling when the original framework was designed in the early 2000s. We now have not only a richer data set to support the quantitative analysis, but also almost a decade of experience with implementation of the framework.

The Committee has therefore undertaken a fundamental review of the simpler approaches for operational risk based on extensive data relating to operational risk losses and exposure indicators from a wide range of banks. These data were assembled in several exercises, including the 2008 Loss Data Collection Exercise, the 2010 Quantitative Impact Study (QIS) and, more recently, specific collections on operational risk losses and candidate proxy indicators based on supervisory reports and other sources available to the Committee’s members. Another loss data collection effort (the new QIS) is under way in parallel to this consultation, the results of which will be used to validate the proposals outlined in this paper.

The Committee’s preliminary findings, based on the existing data, indicate that the current standardised framework comprising the BIA, TSA and ASA is on average undercalibrated, especially for large and complex banks, and that Advanced Measurement Approaches (AMA) capital charges are often benchmarked against this undercalibrated capital requirement. Reflecting this concern, the revised Standardised Approach (SA) attempts to improve the calibration while addressing the weaknesses of the existing approaches identified above.

The Committee welcomes comments on this consultative document by Tuesday 6 January 2015.

Press release

Full consultative document

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