Does Basel’s op risk internal loss multiplier add up?

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As US agencies mull capital reforms, one regulator questions past losses as an indicator of future op risk

As they attempt to implement the Basel Committee on Banking Supervision’s giant post-crisis package of capital reforms, US regulators could be dancing in the dark.

Its prudential agencies need to toe a delicate line between trying to produce a final rule that has bipartisan support ahead of the November presidential election – while also avoiding major deviations from the Basel III text that might alienate other global regulators.

One of the obvious ways to square this circle would be to eliminate any components of the July 2023 package that would make the US Basel Endgame tougher than the equivalent rules adopted in Europe.

Republican rule-maker Travis Hill – Federal Deposit Insurance Corporation vice-chair – has already flagged up one such component in the operational risk framework.

I suspect the proposal overstates our ability to understand and predict operational riskTravis Hill, FDIC

Basel proposes the new standardised approach to op risk should include an internal loss multiplier that would adjust each bank’s capital requirements based on the previous 10 years of historical op risk losses. Yet it also gives individual jurisdictions the discretion to set the multiplier to one – a discretion the European Union has already exercised, but in its first draft, the US has not.

In a response to the proposals in July last year, Hill said he thought it should.

“The proposal states definitively, ‘Higher historical operational losses are associated with higher future operational risk exposure’,” said Hill. “I suspect the proposal overstates our ability to understand and predict operational risk.”

It’s not just a case of political compromise – thanks to industry initiatives, we have the data to analyse whether Hill’s suspicions are correct.

ORX News, which provides Risk.net with monthly data on op risk losses, now has figures going back more than a decade. Its parent, the Operational Riskdata Exchange Association was founded – ironically enough – to collect op risk data for the advanced measurement approach to op

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