Data error inflated Wells Fargo’s op risk capital by $5 billion

Sharp fall in Q1 RWAs followed removal of duplicate data

ORX-Wells-Fargo-0618.jpg

Faulty data led Wells Fargo to overstate its operational risk capital charge for the fourth quarter of 2019 by $5.2 billion, raising further questions on the soundness of the bank’s op risk management.

In its regulatory filing for the first quarter, the San Francisco-based lender revised its op risk-weighted assets (RWAs) amount as of Q4 2019 to $338.7 billion. The previous filing had pegged the amount at $403.6 billion, 19% higher. Minimum regulatory capital charges are set at 8% of RWAs, meaning Wells Fargo held $32.3 billion of op risk capital at end-2019. As of Q1, op RWAs totalled $335.7 billion, 17% lower than the original Q4 2019 amount.

A spokesperson for the bank said: “The revision was due to duplicative data from a third party, and once the matter was identified the result was a favourable impact to regulatory capital under the advanced measurement approach.”

Wells Fargo did not disclose the identity of the third party – but in its latest Pillar 3 regulatory disclosure, the bank says it uses ORX, the industry op risk data exchange, to source external operational risk loss data. ORX said it does not comment on individual members or their data.

An op risk expert at another US bank said the abrupt revision was unlikely the result of a “fat finger” error. “Given the importance of that number, it’s more likely it’s the result of a change in the categorisation of the loss event,” he said.

“It could be that they had two events in their loss data set that they initially thought were separate that have now been determined to be the same. For example, they could have previously treated a group of lawsuits as separate events and these have now been classified as one broader event,” he adds.

The snafu did not impact the bank’s risk-based capital requirements, since in both Q4 2019 and Q1 2020 Wells was bound by the standardised approach, which sets capital using credit and market RWAs calculated using regulator-set formulas and does not include an op risk component. Under the US supervisory framework, the constraining risk-based requirement is the higher of that set by the standardised and advanced approaches – which includes op risk capital.

The revision was due to duplicative data from a third party, and once the matter was identified the result was a favourable impact to regulatory capital under the advanced measurement approach
Wells Fargo spokesperson

Big US banks use the advanced measurement approach (AMA) to calculate op RWAs. Wells Fargo’s AMA model incorporates internal loss data from its own database, and external loss data through membership of ORX, which is used to benchmark RWAs to a bank’s peer group, and to help estimate future op risk losses through such techniques as scenario analysis.

However, the frequency and severity of historical losses plays an outsized role in the AMA. Flawed op risk data, therefore, can materially affect the RWA amounts generated by an AMA model.

“AMA models were calibrated in the US under rigorous standards that the Fed has set. One element people dislike is looking at the empirical loss data as a floor, which you need a very strong justification to violate,” says the op risk expert.

The Federal Reserve, Wells’ primary regulator, declined to comment. However a person familiar with the Wells Fargo issue at the Fed said he had not observed a bank restating its op RWAs in this way before.

 

 

Bank data fidelity is monitored by the Fed, and issues affecting op risk management systems, processes and data can be dealt with through supervisory actions. For example, the Fed can declare a “matter requiring attention” or “matter requiring immediate attention” following a bank examination if it unearths an issue that could undermine the safety and soundness of an institution or that represents significant noncompliance with applicable laws or regulations.

Since February 2018, Wells Fargo has been bound by an asset cap of $2 trillion imposed by the Fed after it was found to have mis-sold “ghost accounts” to unsuspecting customers. The cap will be lifted at the Fed’s discretion following an overhaul of its op risk management framework.

Speaking at a virtual industry conference in May, Wells Fargo chief executive Charles Scharf said that it’s “very, very clear” what the bank has to do to remove the cap. “We’re doing the work. It’s a hard thing to talk about because we have milestones. We know exactly what we have to accomplish. But ultimately, it’s up to the Federal Reserve to decide when it's been done to their satisfaction.”

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