French banks under pressure to hold more op risk capital

PARIS – Rogue traders and a worsening financial crisis are leading French regulators to put pressure on banks to hold more capital for op risk

French authorities are demanding that the country’s banks to hold more capital in the wake of the financial crisis and the Jérôme Kerviel rogue-trading incident at Société Générale (SG) discovered in January 2008.
“The regulators are scrutinising every aspect of our op risk framework and asking us to justify each calculation and action,” says one source. “They want us to hold more capital but they are not telling us how to do it. As we add more capital, we move further away from our approved framework, which the regulator then wants us to justify. It’s a vicious circle.”

All European regulators are urging banks to hold more capital but operational risk management seems to have been largely overlooked by supervisors. However in France the Kerviel incident threw into sharp relief the importance of banks not only having an effective control and operational risk management framework in place, but also having suitable op risk capital. Sources suggest that, at the time of the incident, SG’s op risk capital number was €1 billion, while Kerviel lost €4.9 billion. Kerviel is on trial in Paris for the alleged fraud.

Work is ongoing at the Basel Committee on Banking Supervision’s standards implementation sub-group on operational risk to review how op risk capital is calculated under the existing three Basel II approaches. The work is focusing on the relationship between the alpha in the basic approach and the betas in the standard approach, with some suggesting the beta percentages could simply be raised. “An 18% beta for capital markets business is way too low,” says one banker, “especially as it is that business line that caused all the trouble. Raising the alpha calculation, however, would unfairly penalise the retail business line, which wasn’t at all to blame.”