May 31, 2001

The Basel Committee on Banking Supervision's Second Consultative Package on the New Basel Capital Accord

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Second Consultative Package on the New Basel Capital Accord

Stated Purpose:

To align regulatory capital requirements with underlying risks

Summary of RSP Comment:

The Basel Committee on Banking Supervision is appropriately drawing attention to the need for supervisors to look at operational risk. Nevertheless, the Committee's proposed framework for capital charges for operational risk is seriously flawed.

First, by largely relying on capital charges to mitigate unexpected operational losses, the Committee is undermining the other two pillars of supervision: supervisory review and market discipline. A combination of well-designed systems and controls and insurance that satisfies minimum requirements is a reasonable substitute to regulatory capital for mitigating operational risk and is an approach that would be far less expensive for supervisors to implement. As important, this would also give supervisors market-based assessments of the level of risk at each institution.

Second, the Committee's specification of selected quantitative models may undermine ongoing private sector efforts to develop better ways to measure and mitigate operational risk. The Committee should only provide general direction for the development of models by describing the performance characteristics supervisors expect.

Third, the purpose of the regulatory capital standards should be to provide a safety net that ensures banks have enough resources to allow supervisors the time to respond to a catastrophe before the institution fails. Supervisors should not be attempting to approximate economic capital requirements for individual banks. That is what markets are for. In the attempt to make regulatory capital better reflect underlying risk, each round of proposed revisions is making the Capital Accord more complex and more expensive to administer. There seems to be no natural end to this trend. The resources banks and supervisors are spending to implement the framework are already very large and growing continually. These costs are not fully justified.