Operational Risk Regulation in Banking

Regulatory Influences on Operational Risk

• The Basel Committee on Banking Supervision, located at the Bank for International Settlements, shapes global banking regulations.
• Initially comprised of G10 countries, its membership now includes additional countries such as Brazil, China, and South Africa.
• The Committee sets guidelines aimed primarily at internationally active banks, which have evolved into global standards, influencing regulations like the EU Capital Directives.

Supervision of Operational Risk by National Authorities

• National supervisory bodies utilize staff with specialized skills or external consultants for detailed operational risk analysis.
• Resources are allocated based on current threats, with increased focus on business continuity post-9/11 and documentation risk after the financial crisis.
• Supervisors enforce policies and guidance linked to international standards, with approaches varying based on local legal culture.
• Emphasis is placed on corporate governance, holding senior executives accountable for operational risk management.

Regulatory Compliance and Enforcement

• Regulators prefer cooperative relationships with firms, expecting positive responses to supervisory signals; failure can lead to escalating powers and enforcement actions.
• Major financial scandals (e.g., LIBOR and foreign exchange manipulation) have prompted hefty fines and intensified regulatory scrutiny.
• Outsourcing is now a critical aspect of supervision, with regulators monitoring both the firms and the outsourced entities.

Key Operational Risks of Regulatory Concern

• Business continuity management risk gained prominence after 9/11; firms must have and test effective plans in live scenarios.
• Legal and documentation risks are increasingly scrutinized, ensuring that legal practices and documentation align with current standards.
• Recent events have undermined regulatory confidence in banks' risk models, prompting a shift from the Advanced Measurement Approach (AMA) to a new standardized approach.

Operational Risk Capital Calculation for Banks

• Basel III reforms were implemented to standardize operational risk capital requirements, effective January 1, 2022.
• The operational risk capital formula is Operational risk capital = BIC x ILM, where:
  • BIC (Business Indicator Component) incorporates three components: interest, leases and dividends; services; and financial components.
• Focus is now on utilizing a bank’s income and historical losses to establish operational risk capital requirements.

Explore how national authorities oversee operational risk management and the regulatory framework for operational risk capital in banks. This quiz delves into key regulatory concerns associated with various types of operational risk. Test your knowledge of the complex regulatory landscape that impacts the banking sector.