This letter is the response from the Institute of Operational Risk (IOR)1 to the PRA’s Consultation Paper CP12/17.
The IOR welcomes the PRA’s revised disclosure proposals and their stated purpose of “…bringing greater clarity, consistency and transparency to the PRA’s capital setting approach.” The IOR has, however, two recommended enhancements intended to:
- Reduce the inconsistencies between the disclosed capital requirements of firms variously adopting either the Advanced Measurement Approach (AMA) or The Standardised Approach (TSA); and
- Remove the inconsistencies between the disclosure of Credit Risk losses (i.e. impairment charges) and Operational Risk (Op Risk) losses.
Reducing the inconsistencies between disclosed Op Risk capital requirements
The PRA’s proposals restate the purpose of Pillar 2A capital i.e. it “protects firms against risks that are not, or not fully, captured under Pillar 1”. This is clearly especially relevant to Op Risk capital requirements, as the Basel Committee on Banking Supervision (the Basel Committee) has previously observed that the “simple approaches for Operational Risk – the Basic Indicator Approach (BIA) and the Standardised Approach (TSA)…do not correctly estimate the Operational Risk capital requirements of a wide spectrum of banks.”2
Additionally, the Basel Committee has also previously noted that there are issues with AMA i.e. “…the lack of comparability arising from a wide range of internal modelling practices have exacerbated variability in risk-weighted asset calculations, and have eroded confidence in risk-weighted capital ratios.”3
These issues are illustrated in Figure 1, which is an analysis for 13 large US, Swiss, European and UK banks of:
- Pillar 1 Op Risk capital requirements for 2016;
- The peak annual litigation charges / settlements4 between 2008 and 2016; and
- Average annual litigation charges / settlements for 2008 to 2016.
To read more download the full letter response here: