I expect that there will be further public supervisory guidance on these and other key elements of the IRB approach this year. BIS Review 5/2003  3  Operational risk is another area where the Basel Committee is developing a new regulatory capital approach that seeks to provide incentives for banks to improve their management of risk - - one that is designed to build on banks’ rapidly developing internal assessment techniques, and to accommodate industry innovation over time. Now that the industry is developing a more refined sense of operational risk - the risk of losses caused by failures in processes - the New Accord will “unbundle” this risk and allow banks to differentiate between, and manage separately, their exposures to credit, market, and operational risks. As with market and credit risk, supervisors will use a number of qualitative and quantitative criteria to ensure the integrity of the approaches that banks develop internally - but with the criteria structured to be flexible enough to allow for a wide range of qualifying approaches. By allowing banks to test and experiment with a variety of operational risk methodologies and measures, we think that the New Basel Accord’s approach to operational risk will be a true catalyst for innovation. Timing for the New Accord As you may know, the revision of the international regulatory capital framework has represented a monumental commitment on the part of both banks and supervisors worldwide and has been, so far, nearly four years in the making.
This group is responsible for promoting the consistency and quality of implementation of the New Accord and facilitating the exchange of information among national supervisors about bank and supervisory practices. Through the AIG, senior line supervisors - that is, the people who actually assess banks’ risk profiles - are seeking ways for examiners to validate and supervise internal risk assessment processes in a more consistent fashion across jurisdictions. Implications of Basel II on the supervisory approach We’ve also continued to think about how we should adjust our method of supervision to incorporate the tenets of the new framework, which brings me to the third and final area that I would like to address today. Naturally, allowing banks to rely on internal models in determining their capital requirements has led, and will continue to lead, to changes in our supervisory process. Fortunately, we have the benefit of some experience already at our side. In 1996, under the “market risk amendment” to the original Basel Accord, qualifying banks with large market risk positions were first permitted to incorporate internal estimates of the associated risk in their regulatory capital requirements. When determining whether a bank may rely on its market risk model for capital purposes, our examiners have had to evaluate the technical underpinnings of the model, as well as the risk management and control processes surrounding its implementation and use.