Earlier this year, the Commission had proposed that banks set aside 20% of current minimum regulatory capital to cover operational risks. However, following protests from the banking industry, it is now proposing a 12% requirement. In announcing the reduced requirement, the Committee noted that banking organizations currently make use of insurance to mitigate exposure to operational risk.
The Basel Committee, which contains representatives of the G-10’s central banks, now believes that operational risk has increased significantly over the past decade due to banks’:
- reliance on automated technology and e-commerce
- involvement in large mergers that require the integration of existing systems
Operational risk has been defined by the Committee as “the risk of loss resulting from inadequate or failed internal processes, people and systems or from external sources.”
The new guidelines for capital adequacy in the international banking system are due to be finalized by year-end and were to be in practice by 2004. That deadline has now been extended to 2005.
The Committee noted that effective risk management and control required:
- the bank to have a well-documented, independent operational risk management and control process, including firm-level policies and procedures concerning, and strategies for mitigating, operational risk
- the board of directors and senior management to be “actively involved” in the oversight of the operational risk management process
- regular reporting of relevant operational risk data to business unit management, senior management and the board of directors
- the regular review of the operational risk management processes by internal auditors – both the activities of the business units and the operational risk management and control process.
In 1988, the Basel Capital Accord outlined the agreement among the G-10 central banks to apply common minimum capital standards to their banking industries. Those standards, which were implemented in 1992, were almost entirely focused on credit risk, the risk of counterparty failure, viewed as the main risk incurred by banks. At that time the target standard ratio of capital to weighted risk assets was set at 8%.
In 1996, the Accord was modified to cover the market risks in bank securities trading operations.
Less Costly Disclosure
In a separate working paper, the Basel Committee also said it has “significantly” reduced the amount of disclosure required by banks under the proposed guidelines. While noting the importance of banks having access to information about the risks faced by others, and the procedures for dealing with them, the committee lowered the proposed requirements in light of the costs of providing that data.