Op risk rules inadequate, says Isma professor

The Basel II capital accord rules regarding operational risks for financial institutions are inadequate, Jacques Pézier, a visiting professor at Reading University’s Isma Centre, told delegates at a conference in London this morning.

Pézier said he would encourage banks “not to look at operational risk losses in isolation" and not "to rely on the Basel proposals for definition of operational risk losses" when it comes to calculating capital charges.

Basel II, which all internationally active banks should adopt by 2007, currently has three stages for operational risk capital charges: a basic indicator approach, a standardised approach and an advanced measurements approach. But all three approaches fail to encourage tighter risk manangement, Pézier claimed.

Specifically, under the standard approach, the linear model fails to provide incentives for better risk management, Pézier claimed. Under this approach, capital charges are 12% if the financial entity is operating as a retail bank, asset manager or retail brokerage; 15% if it is a commercial bank; and 18% if the bank is offering corporate finance, trading and sales or payment and settlement functions. But the approach ignores diversification, Pézier added, leading to “falsely safe” models and assumptions.

Also, since the exposure of financial industries to operational risks may be on the increase, operational risks need to be assessed and alternative strategies examined, Pézier added. “But risk management is an integral part of good management, and too narrow a focus, based on Basel II rules, could lead to sub-optimal decisions.”

When asked whether the Basel II operational risk rules were realistic, 56% of the delegates at the conference, hosted by software company SAS, said they were unhappy with the rules. A total of 62% said they were concerned about inadequate data for calculating capital charges across operational, credit and market risk.

Paul Lyon

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