Apra exec defends modifications

SINGAPORE – An executive from the Australian Prudential Regulatory Authority (Apra) defended the supervisor's decision to dramatically modify its approach to the Basel II standardised approach in a discussion paper released at the end of July.

In the paper, the regulator dismisses both the basic indicator approach and the standardised approach as producing "wide variations in outcomes" among financial institutions "that cannot be tied readily to differences in operational risk". Instead, firms that do not adopt the advanced measurement approach will be forced to use the alternative standardised approach, in which the op risk capital charge is calculated as a percentage of the firm's assets.

The executive, Judy Lau, senior manager, supervisory support division at Apra, said at a conference in Singapore in mid-September: "The basic indicator approach actually comes out with a very big variation in the capital requirements that we do not think aligns with the actual op risk in institutions."

Apra has also modified the business line framework established by the Basel Committee on Banking Supervision and consolidated the eight business lines into just two, with betas of 15% and 18%. The discussion notes: "The aggregation of activities into two areas of business simplifies the regulatory capital methodology without significantly dampening the sensitivity of the approach or materially increasing the regulatory capital charge."

Lau said: "We do not believe the extra effort of trying to match the business lines results in a better measure of op risk."

However, the regulator is sticking close to the Basel II proposals in other areas. Banks will be forced to prove that their op risk models "meet a strong soundness standard comparable to a 99.9% confidence level and one-year holding period, which is broadly equivalent to, for example, a Standard & Poor's rating of BBB. The ADI must also demonstrate how its internal operational loss data, relevant external data, scenario analysis and factors reflecting the ADI's business environment and internal control systems are incorporated into its measurement approach, to ensure that it captures potentially severe 'tail' loss events," said John Laker, chairman of Apra, in a recent speech in Australia.

Apra – which won the Operational Risk Achievement Award in 2005 as 'regulator of the year' – is pushing its banks hard to meet Basel II deadlines.

Comments on the operational risk discussion paper are due in by December 31 2005. OpRisk

Firms that do the advanced approaches for credit risk will also have to apply the AMA, and these firms will have to apply with the regulator before the end of the year for permission to implement these. The accreditation process will take place throughout next year. However, there is one hiccup – the discussion paper for the AMA was not due to be released by the regulator until the end of September or beginning of October. This gives banks just three months to put their proposals together.

In fact, many banks have just ploughed ahead and put their applications together, after discussions with the regulators and aid from consultants. All of Australia's major banks are undertaking the AMA.

The regulator also released draft standards on corporate governance in May, which Lau likened to an Australian version of Sarbanes-Oxley. Apra already has existing standards on outsourcing and business continuity.

Operational Risk