Fed economist sounds alert over op risk capital arbitrage

Insurance payouts could allow banks to pare back capital without equivalent reduction in risk, says paper

Fat-tailed risks
Banks could be left without sufficient capital to cover fat-tailed risks such as a natural disaster

Recent research has reignited debate over how banks use insurance to reduce operational risk capital, with experts warning that incoming rules may encourage firms to “arbitrage” the system.

The standardised approach for operational risk allows banks to deduct insurance payouts from their op risk capital calculation. Marco Migueis, an economist with the US Federal Reserve Board, says this may incentivise banks to insure predictable, small-ticket op risk losses at the expense of large, black-swan

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