| "Basel II" has been in the news an awful lot | | | | a more advanced approach no longer meets the |
| these past 18 month or so. Unlike Basel I the | | | | qualifying criteria for this approach, it may |
| new standard introduces a capital charge | | | | require the bank to go back to a simpler |
| based on operational risk. The words | | | | approach for some or all of its operations, |
| Operational risk themselves immediately raise | | | | until it meets the conditions specified by |
| a whole bunch of questions; What is "Basel | | | | the supervisor for returning to a more |
| II"? What is operational risk? How is the | | | | advanced approach.A bank will be permitted to |
| charge going to be calculated? What are the | | | | use the Basic Indicator or Standardized |
| operational risk standards that banks will | | | | Approach for some parts of its operations and |
| have to comply with?Basel II or to use is | | | | an AMA for others provided certain minimum |
| full name "International Convergence of | | | | criteria are met. The conditions under which |
| Capital Measurement and Capital Standards" | | | | this is permitted are;-All operational risks |
| defines operational risk as "the risk of loss | | | | of the bank's global, consolidated operations |
| resulting from inadequate or failed internal | | | | must be captured- All of the bank's |
| processes, people and systems or from | | | | operations that are covered by the Advanced |
| external events". This definition explicitly | | | | Measurement Approaches must meet the |
| includes legal risk but excludes strategic | | | | qualitative criteria for using an AMA, while |
| and reputational risk.In terms of the Basel | | | | those parts of its operations that are using |
| II Accord there are three methods for | | | | one of the simpler approaches meet the |
| calculating the capital charges for | | | | qualifying criteria for that approach-At |
| operational risk. The methods provide a range | | | | implementation of an AMA, a major part of the |
| of increasing sophistication and risk | | | | bank's operational risks must be captured by |
| sensitivity. The three approaches are:-Basic | | | | the AMA-The bank must provide its supervisor |
| Indicator Approach (BIA) - which requires | | | | with a plan specifying its intended timetable |
| banks to hold capital for operational risk | | | | for implementing the AMA across all its |
| equal to the average over the previous three | | | | operationsThe Basel Committee expects that |
| years of a fixed percentage of positive | | | | such approvals will only be granted on an |
| annual gross income.-Standardized Approach - | | | | exceptional basis and limited to |
| which uses gross income across eight business | | | | circumstances where a bank is prevented from |
| lines as a stand-in for the level of business | | | | meeting these conditions because of |
| operations and therefore the probable size of | | | | implementation decisions of supervisors of |
| operational risk exposure within each | | | | the bank's subsidiary operations in other |
| business line.-Advanced Measurement | | | | (foreign) jurisdictions.Despite the relative |
| Approaches (AMA) - this requires a bank to | | | | brevity of the Operational Risk section the |
| calculate its regulatory capital requirement | | | | Accord, the source material for risk |
| as the sum of expected loss and unexpected | | | | mitigation is wide and deep indeed. The |
| loss. This is a highly complicated process | | | | following is a brief list of some of the |
| and still remains the subject of much | | | | current Basel guidelines dealing with various |
| controversy.The Basel Committee has | | | | aspects of operational risk.-"Sound Practices |
| encouraged banks to move along the range of | | | | for the Management and Supervision of |
| available approaches as they develop more | | | | Operational Risk"-"A framework for Internal |
| sophisticated operational risk measurement | | | | Control Systems in Banking |
| systems and practices.Internationally active | | | | Organizations"-"Internal Audits in Banks and |
| banks, as well as banks who have significant | | | | the Supervisors Relationship with |
| operational risk exposures (such as | | | | Auditors"-"The compliance function in |
| specialized processing banks) are expected to | | | | banks"-"Consolidated KYC Risk |
| use an approach that is more sophisticated | | | | Management"-"Risk management principles for |
| than the Basic Indicator Approach and which | | | | electronic banking"-"Management and |
| fits the risk profile of the institution.A | | | | Supervision of Cross-Border Electronic |
| bank will not be allowed to revert to a | | | | Banking Activities".Stanley Epstein is a |
| simpler approach once it has been approved | | | | Principal Associate and Director of Citadel |
| for a more advanced approach without | | | | Advantage Ltd., a consultancy dealing in bank |
| supervisory approval. However, if a national | | | | operations and specializing in Operations |
| bank supervisor determines that a bank using | | | | Risk and Payment Systems. |