#ORBC

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 …