Operational risk – Revisions to the simpler approaches - consultative document

This publication is available on the BIS website (www.bis.org). Operational risk – Revisions to the simpler approaches iii Executive summary Introduction 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 …