Basel III endgame: Outsized operational risk impact

Since the end of July 2023, when the Fed, FDIC, and OCC released their long-awaited proposal to implement the final components of the Basel III agreement, also known as Basel III endgame, banks and other interested parties have been actively assessing its impact on all four categories of banks in the Fed’s regulatory tailoring framework. 

A primary area of focus for this assessment has been the proposal’s impact on operational risk capital. The proposal replaces the current internal models based approach (i.e. the advanced measurement approach) with a new standardized measurement approach (SMA) for assessing operational risk capital that is only partially aligned to the global Basel framework and implementations in other jurisdictions.¹

This scrutiny has been recently bolstered by in-depth analysis of member data from ORX, the financial services operational risk management association. While there are numerous contributing aspects of the proposed changes, there are several increasingly clear implications of the Basel III endgame proposal:

• The proposed U.S. formulation of operational risk capital calculation would substantially increase capital requirements relative to the implementations in the EU and UK
• The level of capitalization for operational risk, when measured in relation to historical stressed losses, is substantially higher than for credit risk
• Historical operational losses are unevenly distributed, and banks with low historical operational risk losses will be most negatively impacted by the proposed rule

With the regulators having recently extended the comment period for the proposal until January 16, 2024, it is likely that banks will further push for adjustments to the operational risk formulations, particularly as the regulators have not provided detailed rationale for these implications. 

In this Our Take Special Edition, we will explain the components of operational risk RWA calculation and the data from ORX supporting these implications.

_{1. Under the current U.S. proposal, banks will be required to calculate their RWA under the SA and what the proposal describes as the “expanded risk-based approach,” which includes the new operational risk SMA. Banks would be bound by the higher of the two approaches.}

Our Take Special Edition:

Basel III endgame: Outsized operational risk impact

Download the report