Regulators not keen to define "significant" international subsidiary

It is highly unlikely that Basel II regulators will have a precise definition of a "significant international subsidiary" in order to make it easier for internationally active banking organisations to determine which of their subsidiaries can calculate their own Advanced Measurement Approach (AMA) operational risk capital requirements.

Addressing the Operational Risk USA 2004 Conference in New York yesterday, Eric Rosengren, the senior vice-president and chief discount officer at the Federal Reserve Bank of Boston, said the banking industry should not expect a precise definition of a “significant subsidiary” because there was still uncertainty about how large a bank must be to implement an effective AMA.

Rosengren also said that while many internationally active banks wanted to be able to allocate risk-based capital to their subsidiaries based on a group-wide risk calculation, regulators were concerned that such parent banks were capable of walking away from their subsidiaries in times of significant loss.

“The industry wants a perfect capital transfer ability, which eliminates the possibility of parent banks walking away from their subsidiaries, but evidence shows that parent banks can actually walk away from their subsidiaries or branches when loss is significant,” said Rosengren.

Many US banking organisations requested a definition of the word “significant” in order to be able to easily determine which of their subsidiaries could, according to the Basel Committee, be permitted to calculate the AMA requirements on a stand-alone basis.

Jay Newberry, head of operational risk at Citigroup, reiterated this request at the same conference when he said there was a need for regulators to define the word “significant” so that internationally active banks could determine which subsidiaries can calculate some of their capital requirements on the stand-alone basis.

In its Principles for the home-host recognition of AMA operational risk capital, published in January 2004, the Basel Committee is encouraging a “hybrid” approach for AMA banks under which a banking group would be permitted – subject to supervisory approval – to use a combination of stand-alone AMA calculations for significant internationally active banking subsidiaries and an allocated portion of the group-wide AMA capital requirement for its other internationally active banking subsidiaries.

Under the hybrid approach, a significant internationally active subsidiary wishing to implement an AMA and able to meet the qualifying criteria would have to calculate its AMA capital requirements on a stand-alone basis. In calculating stand-alone AMA capital requirements, significant banking subsidiaries may incorporate a well-reasoned estimate of diversification benefits of its own operations, but may not consider group-wide diversification benefits. Other internationally active subsidiaries that are not determined to be significant in the context of the overall group would be permitted – subject to supervisory approval – to use as their pillar 1 charge for operational risk an amount that has been allocated to them from the group-wide AMA calculation.

The Committee released three principles it believes will be useful to guide supervisors on the implementation of the hybrid approach to the allocation of operational risk capital across home and host jurisdictions.

The first principle requires that the calculation of the AMA capital requirements be consistent with the scope of application of the new Accord and the Committee’s recent paper on ‘High level principles for the cross-border implementation of the Accord’. The second principle requires the board of directors and senior management at each level of a banking organisation to have an obligation to understand the operational risk profile at that level of the organisation and ensure risks are managed appropriately, and that the capital held at each level in respect of those risks is adequate. The third principle requires supervisors to balance the principles above with the goal of minimising the burden and cost – for both banking organisations and supervisors – of implementing the AMA on a cross-border basis.

BaselAlert.com