Europe considers wider op risk insurance role in new capital rules

The European Commission confirmed today that it proposes the possible recognition of operational risk insurance as a way of reducing capital charges in all three methods of measuring op risk in its new protective capital rules for banks and investment firms.

The proposal opens up a gap between the commission’s third capital adequacy directive (Cad 3) and the Basel II bank safety standards proposed by global banking regulators for the large international banks of the world’s leading economies. The Basel II proposals would confine the use of insurance solely to banks using advanced approaches.

The commission, the ruling body of the EU, said it was contemplating a wider recognition of insurance because of the wide range of firms affected by Cad 3, which will apply to investment firms as well as banks in the EU.

But the commission said it would recognise op risk insurance only if a number of regulator concerns about the use of insurance were satisfied, including worries about the reliability of insurance cover, its feasibility, and the problems that might be created by transferring risk from one financial sector to another.

The EU rules are in general closely modelled on the complex, risk-based Basel II accord designed by the Basel Committee on Banking Supervision, the body that in effect regulates international banking.

The European Commission wants to bring its new rules into force at the same time as the Basel II rules take effect in late 2006.

Both sets of rules will determine how much of their assets banks, and in the EU’s case investment firms as well, will have to set aside as a buffer of capital to absorb unexpected losses from credit, market and operational risks.