A TEST OF THE STRATEGIC EFFECT OF BASEL II OPERATIONAL RISK REQUIREMENTS ON BANKS

Carolyn Currie

The IUP Journal of Monetary Economics, 2006, vol. IV, issue 4, 6-28

Abstract: The most problematic of the Basel II capital adequacy requirements is the subset of Pillar I, requiring provision for Operational Risk (OR) as distinct from credit and market risk. Previous tests of the strategic effect of this new regulation from three prior Quality Impact Studies (QIS), conducted in G10 countries under the guidance of the Bank for International Settlements, have concluded that OR requirements pose difficulties of definition, implementation and strategic planning. Anticipated strategic effects include dramatic changes to product development, investment and asset mix, as well as the necessity to rapidly develop new risk rating models and techniques, together with vastly expanded internal and external audit compliance routines. Unlike QIS 1, 2 and 3, QIS 4 focuses on operational risk. This paper discusses its approach, in view of the ongoing difficulties that bank experience with operational risk, particularly in the construction of a database. It concludes by listing the unanswered questions that have not even been addressed in four studies of the strategic impact of Basel II’s OR requirements. It also suggests that many smaller banks and emerging nations may not be able to use the sophisticated approaches and hence, will suffer a competitive disadvantage. In view of the drawbacks in the simpler approaches, such as lack of correlation of operational risk and revenue, other indicators such as the standard deviation of efficiency measures are suggested.

Date: 2006
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