Regulatory Practice Letter #14-19 | November 11, 2014

Regulatory Practice Letter #14-19 | November 11, 2014

BCBS Issues Consultative Document on Revising the Operational Risk Simpler Approaches

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Executive Summary

The Basel Committee on Banking Supervision (“BCBS” or “Basel Committee”) issued a consultative document on October 6, 2014, entitled Operational Risk – Revisions to the Simpler Approaches. The BCBS seeks comment on its proposal to address weaknesses identified in the existing set of non-model-based approaches for operational risk, including the Basic Indicator Approach (“BIA”), the Standardized Approach (“SA”), and the Alternative Standardized Approach (“ASA”). The Basel Committee’s preliminary findings indicate that the current BIA, SA, and ASA methodologies are, on average, under-calibrated, resulting in a failure to correctly estimate the operational risk capital requirements of a wide spectrum of banks.  Additionally, capital charges derived from the Advanced Measurement Approaches (“AMA”) are often benchmarked against this under-calibrated capital requirement.

The weaknesses of the simpler approaches stem from the assumption, deemed by the BCBS to be invalid, that a bank’s operational risk exposure increases linearly in proportion to its revenue, thereby allowing gross income (“GI”) to be used as a proxy indicator for operational risk exposure. As proposed, the revisions would:

  • Refine the operational risk proxy indicator by replacing GI with a statistically “superior” measure of operational risk, termed the Business Indicator (“BI”) and comprised of the three macro-components of a bank’s income statement, namely the “interest component,” “services component,” and the “financial component;” and
  • Improve the calibration of the regulatory coefficients, preliminarily identified as a five-bucket structure with corresponding coefficients increasing in value from 10 percent to 30 percent as the BI increases in value. These size-based coefficients would replace the current differentiation by business line, which was not found to be a significant driver of risk by the Basel Committee.

The BCBS notes that the number and widths of these buckets, as well as their escalating corresponding coefficient values, represent tentative conclusions based on the results from their most recent quantitative analysis that will be further refined using loss data collected as a part of the Basel Committee’s ongoing Quantitative Impact Study (“QIS”) exercise.

Comments on all aspects of the consultative document will be accepted through January 6, 2015, and will be published on the Bank for International Settlements website unless a respondent specifically requests confidential treatment.

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