November 25, 2012 9:39 pm

Banks face more regulation over risk

Former UBS banker Kweku Adoboli arrives at Southwark Crown Court in London on September 14, 2012©AFP

Several high-profile scandals for banks, ranging from JPMorgan ’s hefty trading loss to UBS ’s rogue trader, have sparked a new regulatory drive to force lenders to spend more time and probably hold more capital guarding against such operational risks.

The Financial Stability Board, the global banking regulator, and the Basel Committee on Banking Supervision, which sets global capital rules, have recently announced plans to tackle the issue next year as part of efforts to make the world’s biggest banks safer.

Operational risk covers almost any problem – bar trading losses, bad loans and legal cases – that could damage a bank, such as the weeks of computer problems at Royal Bank of Scotland.

The “London whale” trading scandal at JPMorgan cost the bank more than $6bn in losses and unauthorised trading by Kweku Adoboli led to losses of $2.3bn at UBS.

In Britain, the payment protection insurance debacle has so far cost the UK banking industry more than £10bn.

Regulators are particularly concerned that banks may not have enough capital to cover losses from operational risk and may not be doing enough to tackle potential problems when many are slashing back-office staff and technology expenditure.

“Banks are trying to do more with less, so you can see that the risk is very much growing,” said Julie Dickson, the senior Canadian regulator who has helped lead the charge at the FSB.

“This is about a lot more than capital. It is about what your operational risk group does on a day-to-day basis.”

Technology and infrastructure issues are critical, including business continuity, outsourcing and data protection, people and conduct problems as well as mis-selling and other product-related problems.

As a rule of thumb, roughly 50 to 75 per cent of a big bank’s capital requirements stem from credit risk, 10 to 20 per cent from operational risk and the rest from trading. Regulators are already rethinking the capital rules for credit and trading, and operational risk is next on the agenda.

Stefan Ingves, the Swedish central banker who chairs the Basel group, said recently that his group’s 2013 agenda includes plans to “improve” the standard method for measuring operational risk.

The committee will also discuss whether to set new minimum capital levels for banks that use their own models to make sure they do not understate their needs.

A spokesman said the Basel committee was also looking at “whether the calibration of the operational risk capital rules is consistent with the magnitude of operational losses incurred”.

Critics of the existing regime say some of the formulas are too closely linked to revenue, so capital requirements drop during downturns even though risks may be rising. The Basel group wants to have a new set of capital requirements by the end of 2014.

Ms Dickson said the FSB wanted supervisors to pry more closely into how well banks are tracking and reducing their risks. “There is an expectation that supervisors are out there testing,” she said.

Tim Thompson, a Deloitte partner, said the industry could benefit. The existing approach to calculating operational risk “has the twin drawbacks of being complex while providing few incentives for better risk management and stronger controls.

“This review provides the Basel committee with a real opportunity to improve on the status quo,” he said.

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