Journal of Operational Risk
ISSN:
1744-6740 (print)
1755-2710 (online)
Editor-in-chief: Marcelo Cruz
Regulatory arbitrage in the use of insurance in the new standardized approach for operational risk capital
Need to know
- The new Basel standardized approach for operational risk capital requirements may suffer from regulatory arbitrage through the use of insurance to cover recurring operational losses.
- This regulatory arbitrage opportunity may be material depending on the degree of feasibility of insurance contracts to exploit it.
- Several alternatives to address this potential regulatory arbitrage opportunity are suggested, including potential modifications to the Basel standard.
Abstract
Basel’s new standardized approach (SA) for operational risk capital may allow for regulatory arbitrage through the use of insurance. Under the SA, banks will likely have an incentive to insure recurring losses. Such insurance can meaningfully reduce capital requirements even though it does not meaningfully decrease tail operational loss exposure. Several alternatives to deal with this potential regulatory arbitrage strategy are discussed.
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