JP Morgan Chase pushes for new op risk measure

Sabatini will soon present a proposal to JP Morgan Chase's capital committee to make operational risk distinct from 'operating risk', which is currently determined through use of a standard benchmark derived and aggregated from several peer group banks.

Sabatini said use of the benchmark is frustrating because it does not reward better-than-average operational risk management.

"There is a significant transition that is underway within our industry," said Sabatini. He added that JP Morgan Chase was in the midst of developing an operational risk framework combining self assesment techniques valid against the bank's loss experience, predictive analysis, risk-based capital methods, and, ultimately, risk mitigation tools.

Sabatini said that such an approach would not only lower the probability of catastrophic losses from operational risk, but reduce the overall probability of losses. "We will end up with improvements from an expected loss function as well as an unexpected loss function," said Sabatini. "These will result in improved and sustainable cost efficiencies, and, if not lower captial, at least allow a better use and more efficient allocation of capital for operational risk."

Sabatini cautioned that success for comprehensive firm-wide operational risk measures in the banking industry was far from guaranteed. Making the benefits of operational risk management clear across a bank and evolving industry standards still needs much work, he said.

But one major boost for operational risk standard-setting has come from the Basel Committee on Banking Supervision's operational risk capital proposals, due to become effective in 2005. "I have some difficulty with some of the proposals, but I think they are directionally correct," said Sabatini. "If it wasn't for these initiatiatives, I don't think our industry would be where it is today."