The Treatment of Operational Risk Under the New Basel Framework - Critical Issues

Abstract

The move of international banking regulation away from rigid controls towards market discipline, prudential oversight and risk-based capital guidelines has steered much attention to operational risk, which has a greater potential to transpire in more harmful ways than many other sources of risk. This article provides a selective discussion of critical constraints on the consistent and cohesive implementation of the existing capital rules under the New Basel Capital Accord. We explain the working concept of the current regulatory treatment of operational risk. In particular, we show how the characteristics of operational risk and flexible operational risk measurement influence the consistency of risk-sensitive capital rules. The implications of our findings inform a more effective regulatory framework.

Keywords: risk management, operational risk, risk management, financial regulation, Basel Committee, Basel II, fat tail behavior, extreme events

JEL Classification: G10, G21, K20