Home-host operational risk capital The third paper published in January laid down key principles regarding the cross-border recognition of operational risk capital charges for those banking organisations that use the advanced options. As you know, one of the improvements of the New Accord is that it will “unbundle” operational risk from other risks and apply a separate capital charge for it. This reflects the emerging view among leading banks and supervisors that we should evaluate and seek ways to reduce losses arising from  4  BIS Review 12/2004  failures in processes, systems, people, or external events. While operational risk is not as readily quantified as these other exposures, the Basel Committee has noted genuine progress among leading institutions in measuring and controlling it. Assigning an explicit capital charge was intended to support these private-sector efforts and to reward firms that develop better measures of operational risk. For the most sophisticated institutions, the “advanced measurement approach” - or “AMA” - is the ultimate expression of the Committee’s goal to incorporate banks’ own sense of risk into the capital framework. Because the AMA is not subject to supervisory “floors,” the Committee expects it to serve as a true catalyst for innovation. The January technical note on operational risk addresses an issue that banks raised concerning the allocation of AMA capital across the subsidiaries of an internationally active banking organisation. Many banks questioned whether operational risk capital requirements should be calculated on a consolidated, institution-wide basis rather than on a legal entity basis.

With regard to this last point, the Committee has decided that the amount of excess provisions that can be included in Tier 2 capital will be limited to a certain percentage of a bank’s risk-weighted assets, which is still to be determined. This change represents a major improvement that will go a long way toward ensuring that a bank’s capital will adequately protect it against unexpected losses and that it will provide incentives to sound provisioning. I am also pleased to note that the early reactions to these changes have been positive. Securitisation The second note published in January addressed changes to the treatment of securitisation exposures. We are particularly committed to developing an appropriate and balanced treatment for banks’ exposures to securitisations since the 1988 Accord does not address this important risk management tool. At the same time, a securitisation transaction can result in an extremely intricate structure, which makes it hard to specify a simple rule. Public comments on our proposals acknowledged this challenge, as many found the proposed capital rules in the third consultative paper for securitisations to be among the most complicated parts of the New Basel Accord. Many also thought the treatment to be perhaps too conservative. In response, members of the Committee pledged in Madrid to streamline the relevant proposals. Equally important, we wanted to adopt, where possible, requirements that are more compatible with the best practices in use today. The note released in January illustrates the progress we’ve made.