Motivation behind the Committee’s proposals Beyond the advanced methods proposed for the treatment of credit risk, the inclusion of a capital approach for operational risk represents one the New Accord’s most notable innovations, to which I’ll now turn. In recent years, banks and supervisors have begun to recognise the need to evaluate and seek ways to reduce losses arising from failures in processes, systems, people, or external events. Increasingly, supervisors, like many leading institutions, consider the management of operational risk to be a comprehensive practice comparable to that of credit or market risk. While operational risk is not as readily quantified as these other exposures, the Basel Committee has noted genuine progress among leading institutions in measuring and controlling it. “Unbundling” operational risk from other risks and then including an explicit capital charge for it was intended to support these private sector efforts and to reward firms that develop better measures. With that motivation, the Committee sought approaches to operational risk that mirror the New Accord’s three pillars of more risk-sensitive minimum requirements, coordinated supervisory review, and enhanced market discipline through greater transparency. Together, the three pillars support the development of sophisticated measures of operational risk and offer incentives for banks to enhance their relevant controls. The Committee recognises that the art of operational risk management is still in its nascence and that risk managers are experimenting with a wide range of methodologies.
Of the public comments on CP3 that touched on the operational risk proposals, it was gratifying that most sought refinement and clarifications of the proposals, and many acknowledged the value of the underlying principles. Respondents addressed a range of issues, but the AMA clearly captured the industry’s imagination. Three themes have emerged that are especially important to the Committee’s work on the AMA. One concerns the qualifying criteria banks will have to fulfil to adopt the AMA. Two others addressed the allocation of operational risk capital and consistency in the application of the AMA standards, across both banks and jurisdictions. I’d like to spend a few moments to give you a sense of the Committee’s deliberations to date on each theme. Qualifying criteria for AMA The first, and perhaps most pressing, of the themes concerns the minimum operational requirements that banks will soon need to meet in order to receive supervisory approval to use an advanced measurement approach. Many respondents felt that the Committee’s requirements spell out a tall order for the industry, especially in terms of the requirements to validate operational risk data and correlation assumptions. The Committee acknowledges that meeting the qualifying criteria will be a significant challenge for some banks. At the same time, the AMA offers banks an unprecedented degree of freedom in modelling their risk and determining their minimum capital requirements. The Committee considers it appropriate to pair this privilege with appropriately demanding standards.