#operational risk – Federal Financial Analytics

18 08, 2023

Al082123

William Cross2023-08-22T09:52:13-04:00August 18th, 2023|3- This Week|

Capital Regulation Deconstructed

Last week, we provided clients with several more in-depth analyses of the interagency capital proposal. Of particular note is our wrap-up report (see Client Report CAPITAL234) which looks hard at the agencies’ own quantitative and qualitative impact assessments to see what the raw numbers say, how the numbers comport with current data and market realities, and – most importantly – how to interpret the agencies’ qualitative conclusions in light of these analytics, as well as our understanding of many of the studies on which key assumptions are premised. As the report details, we agree that the agencies’ rationale for every possible capital woe – that anything is better than a financial crisis – is right. But it’s only right if the result of the rules is to make financial crises less likely and that, as our reports make clear, is far from assured. Many provisions of each key section combined with overall quantitative results could well prove profoundly destabilizing.

Al082123.pdf…

14 08, 2023

M081423

Eliza Allen2023-08-14T10:41:39-04:00August 14th, 2023|6- Client Memo|

Why The Operational-Risk Capital Rules Make No Sense

While there are many risks for which regulatory capital is a vital panacea, operational risk is not among them. The proposed approach to these capital standards makes it still more clear that regulators don’t trust themselves or banks and thus deploy the only tool they seem to know – ever-higher capital – no matter the cost and, more important, the risk. In fact, the best way to address operational risk is to spend money, not put it in a capital piggybank regulators can shake to hear coins rattle when they worry even though getting the coins out in a hurry will prove devilishly difficult.

M081423.pdf…

14 08, 2023

Karen Petrou: Why The Operational-Risk Capital Rules Make No Sense

Eliza Allen2023-08-14T10:41:30-04:00August 14th, 2023|The Vault|

While there are many risks for which regulatory capital is a vital panacea, operational risk is not among them. The proposed approach to these capital standards makes it still more clear that regulators don’t trust themselves or banks and thus deploy the only tool they seem to know – ever-higher capital – no matter the cost and, more important, the risk. In fact, the best way to address operational risk is to spend money, not put it in a capital piggybank regulators can shake to hear coins rattle when they worry even though getting the coins out in a hurry will prove devilishly difficult.

The reason why regulatory capital doesn’t do diddly for operational-risk absorption is self-evident when one understands what constitutes operational risk. It’s essentially what God does to banks (natural disasters), what people do to banks (fraud), and what banks do to themselves (fragile systems) and to others (endangering consumers or markets at ultimate legal cost).

None of these risks is meaningfully reduced with more capital and, even if it were, the way the new rules work frustrates the way it might. As our in-depth analysis of the proposed operational risk-based capital (ORBC) rules makes clear, regulators want banks to look back as long as ten years to see how many operational losses they booked, measure business volume over the past three years, ramp up these sums via mysterious “scaling factors,” and then somehow discern what operational risk will be in coming years and how much shareholder …

11 08, 2023

Al081423

Eliza Allen2023-08-11T16:27:33-04:00August 11th, 2023|3- This Week|

The Capital Construct Continued

Even as we stay on watch for new regional-bank resolution rules, and keep you posted on some high-impact events (see below), we’ve been plowing through hundreds of pages of regulatory-capital rewrites. Last week, we built on our in-depth analyses of the overall capital framework (see FSM Report CAPITAL230) and the new approach to credit risk (see FSM Report CAPITAL231) with several new in-depth assessments.

Al081423.pdf…

10 08, 2023

FedFin on: Operational Risk-Based Capital Standards

Arezou Rafikian2023-08-11T16:25:34-04:00August 10th, 2023|The Vault|

Noting that operational risk is present at all banks due to most activities, the U.S. regulatory-capital rewrite would end the current approach to operational risk-based capital (ORBC). This now subjects only categories I and II banks to ORBC and then only to the advanced measurement approach (AMA) premised on each bank’s internal models. Consistent with the overall decision to end internal-model reliance, this section of the proposal subjects categories I, II, III, and IV banks to a new operational-risk standardized approach (SA). This would result in very steep capital requirements based on a bank’s experience over the past ten years compared to various sources of revenue over the past three years, perhaps taking business-model changes over the course of the last three years into account if regulatory standards are met for doing so….

The full report is available to retainer clients. To find out how you can sign up for the service, click here and here.…

10 08, 2023

OPSRISK22

Eliza Allen2023-08-10T16:10:43-04:00August 10th, 2023|1- Financial Services Management|

Operational Risk-Based Capital Standards

Noting that operational risk is present at all banks due to most activities, the U.S. regulatory-capital rewrite would end the current approach to operational risk-based capital (ORBC). This now subjects only categories I and II banks to ORBC and then only to the advanced measurement approach (AMA) premised on each bank’s internal models. Consistent with the overall decision to end internal-model reliance, this section of the proposal subjects categories I, II, III, and IV banks to a new operational-risk standardized approach (SA). This would result in very steep capital requirements based on a bank’s experience over the past ten years compared to various sources of revenue over the past three years, perhaps taking business-model changes over the course of the last three years into account if regulatory standards are met for doing so. Steps banks have taken to prepare and avoid operational risk and respond to prior incidents are also generally not captured in a meaningful ORBC adjustment. As a result, ORBC capital standards may be premised on risks the bank is now unlikely to encounter on a go-forward basis or offsetting the costs essential to preventing and absorbing the operational risks it now might encounter.

OPSRISK22.pdf…

31 07, 2023

M073123

Eliza Allen2023-07-31T10:40:52-04:00July 31st, 2023|6- Client Memo|

Two Tenets of the Capital Proposal That Make No Sense No Matter How Much One Might Want to Love The Rest of It

In the wake of the 1,089-page capital proposal, debate is waging on well-trod battlegrounds such as whether the new approach will dry up credit and thus stifle growth. I’ve my own view on this, but my initial read of the proposal points to a still more fundamental issue: some of it makes absolutely no sense even if one agrees with the agencies’ goals. Here, I lay out two bedrock assumptions that contradict the rule’s express intent and will have adverse unintended consequences to boot. God knows what lurks in the details.

M073123.pdf…

31 07, 2023

Karen Petrou: Two Tenets of the Capital Proposal That Make No Sense No Matter How Much One Might Want to Love The Rest of It

Eliza Allen2023-07-31T10:40:41-04:00July 31st, 2023|The Vault|

In the wake of the 1,089-page capital proposal, debate is waging on well-trod battlegrounds such as whether the new approach will dry up credit and thus stifle growth. I’ve my own view on this, but my initial read of the proposal points to a still more fundamental issue: some of it makes absolutely no sense even if one agrees with the agencies’ goals. Here, I lay out two bedrock assumptions that contradict the rule’s express intent and will have adverse unintended consequences to boot. God knows what lurks in the details.

The first “say what” in the sweeping rules results from the new “higher-of” construct. Credit and operational -risk models are entirely gone and market-risk models are largely eviscerated. Instead, big banks must hold the higher of the old, “general” standardized approach (SA) or the new, “expanded” SA. Each of these requirements is set by the agencies – models mostly never allowed. Further, a new “output floor” – different from Basel’s approach to this model’s constraint – is also mandated as yet another safety net preventing anyone gaining any advantage from any possible regulatory-capital arbitrage.

Why then not just demand that big banks use a standardized weighting the agencies think suffices? Must banks be put through the burden of calculating two ratios when they have no ability to arbitrage requisite capital weights? Do the agencies not even trust themselves to set capital standards that are now sometimes higher, sometimes lower as God gives them to know probability of default …

28 07, 2023

Al073123

Eliza Allen2023-07-28T17:05:25-04:00July 28th, 2023|3- This Week|

Few Surprises, Much Consternation

There is little in the new capital framework we did not forecast for new capital rules after the March bank failures (see Client Report REFORM219) and what we missed was later presaged in Vice Chair Barr’s recent speech (see Client Report CAPITAL228). However, as we’ve also said many times, many devils lurk in regulatory-capital details. We know the agencies’ capital-impact bottom line because the FDIC and Fed each outlined this at contentious meetings approving the proposal for public comment. We also know that Republicans really don’t like the rule even if they haven’t read it and that key decision-makers – most notably Chair Powell – are hedging their affirmative votes for releasing the proposal with careful caveats of what they want to see in a final rule. Thus, careful analytics are essential to effective assessments of winners and losers as a result of this complex package, especially if one looks – as FedFin will – at big-picture implications – i.e., those for the economy, financial system, and economic equality – as well as at sector- and institution-specific provisions not just in key asset classes based on specific risk weightings.

Al073123.pdf…

27 07, 2023

DAILY072723

Eliza Allen2023-07-27T17:47:02-04:00July 27th, 2023|2- Daily Briefing|

FSB Tries to Calm CoCo Confusion

Doubtless responding to the CoCo chaos when Credit Suisse failed, the FSB today issued a report laying out how cross-border crisis-management groups are to handle unallocated TLAC (UTLAC) such as the “alternative Tier 1” bonds popular in the EU.

FDIC 3-2 Vote Presages Knock-Down Basel Battle

As anticipated, the FDIC today voted 3-2 to issue a sweeping rewrite of U.S. regulatory capital requirements.

Divided, Cautious Fed Advances End-Game, GSIB Rewrites

As anticipated, Gov. Bowman today voted against the new capital framework, as did Gov. Waller; as a result, the vote was 4-2.

Stablecoin Bill Advances, Compromises to Come

At a fiery HFSC markup today, Chairman McHenry (R-NC) announced that bipartisan negotiations had broken down largely due to the White House, choosing to proceed to a final package as he remains open to amendment before floor action.

House Republicans Skewer Basel Rules

Hill comment so far in response to the new capital rules is sparse.

Daily072723.pdf…