| A ‘standards based’ approach to operational risk management under Basel II
In June 2004, the Basel Committee finally released the ‘Revised Framework for the International Convergence of Capital Measurement and Capital Standards’ - in effect, the definitive Basel II proposals on operational risk. During the three years prior to final publication, consultation with the industry had resulted in a pronounced switch in emphasis, away from a mainly quantitative, towards a more qualitative, approach to the management of operational risk. Under proposals for allowing ‘internationally active’ banks to calculate capital using their own internal models – so called AMA (Advanced Measurement Approaches) - the Basel Committee backed away from dictating any explicit methodologies for calculating operational risk capital charges, stressing instead the importance of qualitative standards for management of operational risks. Other than urging that an operational risk management system must be “conceptually sound and implemented with integrity”, Basel II, however, gave few clues as to what such a ‘system’ might look like. As banks (and their regulators) are about to begin investing large sums of money and much time and effort in developing the operational risk management systems necessary for Basel II, it is timely to consider whether there are models outside of finance that could usefully be employed in this context. This paper argues that the wording of Basel II is sufficiently vague that banks are in danger of developing internal ORM systems that run the risk of not complying with interpretations of Basel II by local supervisors. However, there are mature frameworks from other industries upon which the processes of operational risk management could be based. In particular, there are two risk management standards - AS/NZS 4360/2004 and COSO/ERM – that, alone or in combination, could satisfy the requirements of Basel II for systems that are ‘conceptually sound’. This paper also argues that the adoption of operational risk management processes that are based on proven, practical and usable standards, should reduce the overall costs to the industry of complying with Basel II.
•Date:
14th January 2005 •Region: World •Type:
Article •Topic: Operational
risk |
