Brexit may spur higher op risk losses – EBA

Largest five op risk losses in 2018 cost equivalent of 2.1% of EU bank's average CET1

The top five operational risk losses incurred by European Union banks in 2018 cost €35.4 billion ($40 billion) in total, equivalent to 2.1% of their Common Equity Tier 1 (CET1) capital on average – and higher costs are expected next year, driven in part by Brexit uncertainty.   

Data published by the European Banking Authority (EBA) shows that the cost of op risks has increased year to year. In 2017, the five largest losses accounted for just 1.2% of EU banks’ CET1 on average.

Brexit fallout could ramp up op risk losses further in 2019, the watchdog said, as banks are not yet able to handle the legal issues arising from the divorce. More than 50% of respondents to the EBA's most recent Risk Assessment Questionnaire say they expect operational risks to increase.

In addition, almost nine out of 10 banks said cyber and data security threats would increase operational risks, up from just over half of respondents to the previous questionnaire. One in five said money laundering, terrorist financing and sanction noncompliance would act as key drivers pushing op risk higher.

Operational risk-weighted assets made up 10.5% of EU banks’ total RWAs at end-June. Romanian banks had the highest share of total RWAs taken up by operational risk, at 16.2%, and Polish banks the lowest, at 4.8%.  

The French banking sector has loaded up on op RWAs the most across the EU, increasing them by €10.4 billion to €247 billion in the six months to end-June. Dutch banks have cut op RWAs the most, by €2.7 billion to €88 billion, over the same period. 

Who said what

“The uncertainty around Brexit might also further increase operational risk, as banks cannot yet be fully prepared to tackle legal challenges, such as the status of existing contracts, and regulatory regimes as well as IT systems” – EBA Risk Assessment of the European Banking System, December 2018.

What is it?

The EBA publishes an annual report on risks and vulnerabilities in the EU banking sector. This accompanies the results of the EU-wide transparency exercise, which provides details on capital, leverage and profitability for 130 banks across all member states. 

The watchdog also publishes a periodic Risk Assessment Questionnaire, with one set of questions addressed to banks and another to analysts. The results published in the most recent report come from 53 banks and 15 analysts questioned in October 2018. 

Why it matters

Brexit presents a plethora of legal, conduct and regulatory challenges to EU banks. Every facet of UK-EU trading will be affected by the break-up, with a no-deal exit likely to trigger the greatest disruption. The uncertainty of what rules will apply to EU firms that deal with UK entities post-Brexit means that many could breach requirements unwittingly, or simply will not be able to re-paper contracts and establish new trading relationships in time for the March 29 exit date.

Regulators have attempted to provide some relief with the introduction of temporary permissions regimes that will allow firms to continue trading as they do at present for a short window post-Brexit, but the coverage they profess is patchy. 

This means op risk losses are likely to rack up in 2019 and beyond as firms struggle to keep up with shifting standards. It's possible, however, that watchdogs will indulge those firms that breach requirements but have made good faith efforts to be in compliance. Only time will tell.

Get in touch

Will Brexit catalyse operational risk losses? Let us know by emailing [e-mail], tweeting @LouieWoodall, or messaging on LinkedIn. You can keep up with the latest from our team by tweeting @RiskQuantum.

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