Article Published on the Regulatory Capital Consequences of Conduct Risk
2015-12-23 00:00:00 +0000
“A sometime Research Associate of the Foundation has recently published a paper in the Journal of Operational Risk (10(4), 73–111), entitled: 'Modeling operational risk capital: the inconvenient truth". As the Journal’s editor remarks, the paper “...presents a very controversial discussion about the role of operational risk capital in protecting banks. He notes that, since the financial crisis of 2008, large banks have incurred more than US$200 billion of operational risk losses, mainly as a result of regulatory fines, lawsuits and demands for customer redress for various types of misconduct. A basic assumption underlying the modeling of operational risk regulatory capital (ORRC) under Basel II is that such operational risk losses can be modeled as being idiosyncratic to an individual institution, as this is the level at which banks are currently regulated. This paper challenges that assumption and shows that it is an "inconvenient truth" that banks' largest losses are not firm specific. Instead, the largest losses involve multiple banks being fined at the same time by multiple regulators for the same types of misconduct. The author calls such large multibank incidents "systemic operational risk events" and argues that, as well as looking at firm-level problems, ORRC should also be modeled at the "systemic", or macroprudential, level. The paper also discusses arguments made by academics against current approaches taken to modeling ORRC and, finally, makes a suggestion to the Basel Committee that - like the review into market risk that is currently being undertaken - a comprehensive and fundamental review be undertaken into operational risk”.
The Foundation’s Conduct Costs Project database and results are cited by Pat McConnell within the paper. Access to the detailed data underlying the results is available to members of the Project’s Associations (see: http://conductcosts.ccpresearchfoundation.com/about)
Link to the paper: http://www.risk.net/journal-of-operational-risk/journal/2437522/latest-issue-volume-10-number-4-december-2015