Banks divided on op risk approaches

US and Australian banks favour the advanced measurement approach for calculating operational risk capital requirements more than their European and Japanese peers, a Risk Quantum analysis shows.

A survey of 47 of the 50 banks in the Risk Quantum sample showed that 20 had 100% of their op risk capital generated under the AMA as of end-June 2018, of which nine were American, four Australian, two Swiss and one Canadian. Only four European banks calculated their op risk capital exclusively using the AMA.

Thirteen banks used a mixture of two or more of the standardised, AMA and basic indicator approaches (BIA), four of which were Japanese, with MUFG calculating the highest share under the basic indicator approach of any bank, at 32% of their total. Six were European, with BBVA having the largest share of its op risk capital calculated using the BIA, at 16.4%. Three were Canadian, though none of these used the BIA.  

Fourteen banks, of which two were Japanese and the rest European, calculate op risk capital exclusively using the standardised approach.  

What is it?

Basel II rules lay out three methods by which banks can calculate their capital requirements for operational risk – the BIA, the standardised approach and the AMA. The first two use bank data inputs and regulator-set formulae to generate the required capital, while the AMA allows banks to use their own models to produce the outputs.  

The finalised Basel III framework, published in December 2017, will replace these three with a revised standardised approach. This uses a simple accounting measurement of bank total income – known as the business indicator – to divide firms into three size buckets. A separate business indicator multiplier is then applied to each bucket to produce the business indicator component. The product is then subject to an internal loss multiplier, a scaling factor based on a bank’s average historical losses and business indicator component. 

The Basel Committee has set member jurisdictions a deadline of January 2022 to implement the revised standardised approach. 

The survey features nine US banks, 22 EU banks, four Canadian banks, six Japanese banks, two Swiss and four Australian banks, all included in the Basel Committee's global systemically important bank assessment sample. Those excluded from the Risk Quantum sample were Scotiabank, which said it calculates op risk using the AMA and standardised approach, but did not provide a breakdown between the two, and PNC and Capital One, which are not under the US advanced approaches rule and therefore do not disclose operational risk capital data.

Why it matters

Basel’s overhaul of the capital framework eliminated the raison d’être of internal models for op risk, as banks will have to comply with regulatory charges generated under the revised standardised approach going forward.

For some lenders, the switch will lead to a reduction in op risk-weighted assets – Basel’s own impact analysis suggests an aggregate drop of more than 30%. 

However, these savings will not be evenly distributed. European supervisors have generally allowed their banks greater flexibility than their US peers in modelling op risk capital requirements, meaning they have being able to juice more capital savings under the AMA. As a result, they have more to lose from the AMA’s demise. 

This may explain why two European banks – Barclays and BNP Paribas – decided to switch from the AMA to the standardised approach in the middle of last year, well ahead of Basel’s timetable. By scrapping their use of internal models now, the banks are frontloading some of the expected capital volatility that will occur when the revised standardised method comes into force, smoothing the transition to the new capital regime.

As for why US banks have yet to switch off their models, there’s a simple explanation – US regulators have yet to transpose parts of Basel III into domestic law, including the op risk framework, and lenders have no recourse under the current advanced approaches rules to shrug off the AMA. 

Correction, February 6 2018: This article was amended to include ING as one of the banks that exclusively uses the AMA. It had been wrongly identified as not using the AMA in a previous version.

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