The Potential Effect of the New Basel Operational Risk Capital Requirements

Abstract

The three pillars of Basel II introduce new capital ratios, new supervisory procedures, and demand better disclosure to ensure effective market discipline in both the equity and debt markets. Included in these requirements, for the first time, is the necessity for financial institutions to provide for operational risk, as distinct from credit and market risk. This is considered to be most problematic of Basel II requirements, posing difficulties of definition, implementation, and strategic planning. It will affect product development, investment and asset mix, as well as requiring the rapid development of new risk rating models and techniques together with vastly expanded internal and external audit compliance routines. The issues of cost, necessity and difficulties of measuring operational risk are examined in this paper. Apart from micro effects on bank pricing, macro questions of restriction of credit and distortions in systems efficiency need to be addressed. Such issues are considered in the context of reasons for bank efficiency need to be addressed. Such issues are considered in the context of reasons for bank failure and the effect on systemic goals of stability and safety.

Keywords: operational risk, Basel II