Ladies and Gentlemen:
The Clearing House Association L.L.C., the Securities Industry and Financial Markets Association and the Financial Services Roundtable (collectively, the “Associations”)[1] appreciate the opportunity to comment on the Basel Committee on Banking Supervision’s March 2016 consultative document, “Standardised Measurement Approach to operational risk,”[2] which seeks comment on a proposed “Standardized Measurement Approach” for operational risk (“SMA”) to be incorporated within the Basel Committee’s broader capital adequacy framework.
We share the Basel Committee’s view that historical experience has highlighted significant problems with the Advanced Measurement Approaches for operational risk (“AMA”). For that reason, we strongly support the proposed withdrawal of the AMA framework in favor of a more stable and less complex standardized measure of operational risk that both promotes greater comparability and is appropriately risk-sensitive.[3] Further, as suggested above, we support the basic conceptual framework of the proposed SMA, which would combine both uniform, standardized measures of operational risk and firm-specific adjustments that reflect the individual operational risk experience and environment of particular banking organizations. To serve as an appropriate and effective part of the risk-based capital regime, this conceptual framework of the SMA must be put into practice in a way that satisfies two key objectives.
First, any standardized measure of operational risk should be meaningfully calibrated and supported by robust empirical data. Second, any firm-specific adjustments should reflect the existing operational risk environment of individual banking organizations, and not merely historical risk experiences. The failure to achieve either of these key objectives would result in an SMA that is not empirically grounded and/or insufficiently risk-sensitive. As currently proposed, the SMA leaves room for improvement in meeting each of these important objectives.
First, because the proposed SMA would account for organization-specific operational risk profiles via a Loss Component (“LC”) that is wholly backward-looking, it would not reflect the current risk environment of any individual banking organization, but instead only its historical loss experiences, which may or may not be relevant to current operational risks of the banking organization as it evolves and changes over time.
Second, because the SMA would rely on a simplistic financial statement-based measure of operational risk – the Business Indicator (“BI”) component – it would ignore meaningful differences in the operational risk inherent in various bank activities and businesses. In particular, according to a comprehensive survey conducted by The Operational Riskdata eXchange Association on the potential capital impact of the SMA (the “ORX Study”), the correlation between gross income and the BI is 96 percent, indicating that gross income and the BI behave in a very similar manner.[4] Because gross income and bank size are themselves highly correlated, the BI is also highly correlated with size.[5] Accordingly, the result of the BI component is a standardized measure that is primarily sensitive to size, and not to operational risk. For example, two banking organizations with similar size and net income would receive the same BI component, even if the operational risk profile of such organizations was vastly different due to operating completely different lines of business. The size-sensitive (rather than risk-sensitive) nature of the BI component is further exacerbated by the proposal’s disproportionate increase (through increasing coefficients) of the capital charges levied on firms with a higher BI, effectively making the SMA yet another capital surcharge on the size of a banking organization.
Unless these two weaknesses are addressed, the SMA would effectively require banking organizations to hold capital based on size and historical experience, rather than against operational risk, with larger banks required to hold proportionally more operational risk capital and facing the greatest increases in capital requirements.[6] To address these shortcomings, we urge the Basel Committee to incorporate a range of small but effective changes that would make the SMA meaningfully risk-sensitive, better reflecting the current operational risk profile of financial institutions subject to the SMA. We also urge the Basel Committee to explain the SMA’s calibration and provide banking institutions with sufficient information to better understand the calibration and underlying assumptions. Collectively, these steps would ensure that the promising conceptual framework of the SMA is implemented in a way that is empirically tethered, appropriately risk-sensitive and transparently calibrated.
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[1] Descriptions of the Associations are provided in Annex A of this letter.
[2] Basel Committee on Banking Supervision, Consultative Document: Standardised Measurement Approach for operational risk (March 2016), available at http://www.bis.org/bcbs/publ/d347.pdf (“Consultation”).
[3] With respect to the issue of implementation timing, we request that once the SMA is finalized, subject to supervisory approval, banking organizations should have the option to adopt the SMA early, and withdraw from utilizing the AMA
[4] See The Operational Riskdata eXchange Association, CAPITAL IMPACT OF THE SMA, ORX BENCHMARK OF THE PROPOSED STANDARDISED MEASUREMENT APPROACH 5 (May 18, 2016), available at https://www.orx.org/Lists/PublicDocuments/ORX%20Capital%20impact%20of%20the%20SMA.pdf. The ORX Study included 54 internationally active banks, 16 of which are global systemically important banks.
[5] See id.
[6] See id. at 4.
