Transcript
Page 1: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

Are Banks Ready for Basle IIand what are they preparing for…

Operational Risk

Denis PellerinSenior Vice-President

Operational and Market Risk ManagementNational Bank of Canada

Montreal, April 13, 2007

forThe Third International Conference on Credit and Operational Risks

Page 2: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 2

AGENDA

A. CANADIAN BANKS SITUATION– Major Banks Targeted Approach for Operational Risk– Implementation Time Frame– Implementation Context– Role of Regulators and Market Pressure

B. REST OF THE WORLD – Op. Risk Implementation Efforts– Targeted Approaches– Time Frame– Role of Regulators and Market Pressure

C. PROS AND CONS OF EACH APPROACH FOR OP. RISK– Basic approach– Standardised approach : manages the risk– Advanced approach : measures the risk

Page 3: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 3

A. CANADIAN BANKS SITUATION(a system highly concentrated)

A.1 Major banks targeted approach for Operational Risk

– 5 of the Big 6 are aiming for Standardized + 3 other.

– Most of them are also considering Advanced but no commitment.

– CIBC aims for Advanced, another did for a while.

– Banks have all implemented typical risk management framework.

– 5 of the Big 6 are subscribing to ORX.

– Usage of electronic tools to support RCSA rather limited.

– Interesting to note that all Big 6 are aiming for Advanced for credit.

Page 4: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 4

A. CANADIAN BANKS SITUATION

A.2 Implementation Time Frame

– In Canada, BASLE II starts on NOVEMBER 1st, 2007

– All the Big 6 have been working on their Op. Risk implementation for 8 – 10 years

– Big 6 “WILL BE READY”

– OSFI will deliver certification this summer

Page 5: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 5

A. CANADIAN BANKS SITUATION

A.3 Implementation Context

– During this time, several other regulatory or compliance driven initiative:

• Basle II Credit Risk

• Sarbane Oxley

• AML

• Reputational Risk Management

• Personal Information Privacy

• Pandemic Flu Preparedness

• Outsourcing Risk Management

and son on… and Operational Risk, of course…

Page 6: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 6

A. CANADIAN BANKS SITUATION

A.3 Implementation Context

– Produced Regulatory Fatigue :• Risk Managers

• Business Lines

– Confusions from BU as to who does what.

– Most of these initiatives are seen by business lines people as overlapping if not repetitive.

– As banks are about to go live with their Op. Risk Capital Model, will they focus on migrating to Advanced Status?

Page 7: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 7

A. CANADIAN BANKS SITUATION

A.3 Implementation Context (cont.) … Priority to convergence

– Initiative to integrate the various processes implemented to assess and improve internal control environment.

– Convergence main driver: Desire to simplify implementation by business lines (not quality or efficiency).

– Challenge is to preserve “quality” while integrating processes.

– One bank is piloting integrated Risk and Control Assessment Program.

– Other Banks at various preparation stages will all see more actions in the next 12 – 24 months.

Page 8: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 8

A. CANADIAN BANKS SITUATION

A.4 Role of Regulators and Market Pressure (layman terms for Pilars II and III)

– Implementing a regulatory capital model for Op. Risk is a regulatory driven initiative. Role of regulators is key for smooth implementation.

– OSFI is the main regulator of most banks implementing Op. Risk models.

– Material from Basle needs to be completed by regulators guidelines for efficient design.

– If this is new to banks, it is also new to regulators – they too had to learn.

– At first, OSFI didn’t have a dedicated team but eventually they put their act together and started to oversee implementation efficiently.

Page 9: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 9

A. CANADIAN BANKS SITUATION

A.4 Role of Regulators and Market Pressure (cont.)

Two streams – initiated 3 years ago:

1. Gap Analysis:• Consisting of analysis by individual banks to identify

framework shortfalls compared to OSFI and Basle Requirements

• Includes action plans and Timetable to fill in the gaps with regular monitoring

2. Three bench marking exercises: • Gross income mapping

• Loss data collection

• RCSA

• Very useful work also feeding into gap analysis

Page 10: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 10

B. REST OF THE WORLD (Not an accurate picture of the rest of the world…)

B.1 Targeted Approaches

– 3 different approaches to determine regulatory capital for Op. Risk : Basic – Standardized – Advanced.

– They represent a continuum from least to most sophisticated.

– But to get approval to utilise a given model, regulators require that actual risk management practices of op. risk be in line with the selected model. They are also positioned on a continuum.

– There are also unwritten rules :i. prioritize credit risk over operational risk;ii. to be Advanced for operational risk you need to be

Advanced for credit risk as well;iii. the opposite is not true.

Page 11: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 11

B. REST OF THE WORLD

B.1 Targeted Approaches (cont.)

– The amount of financial and human resources required to qualify for a given approach sharply increases as you go up the continuum.

– Natural tendency is for small banks to opt for Basic, midsize banks for Standardized and largest banks targeting Advanced.

– This is a general rule but there are exceptions. The most noticeable being large banks category:

• The largest banks’ group is made of banks with more than 200 G$;

• There are only approximately 40 banks that are aiming for Advanced (1 out of 3);

• 12 of them are American and had the Advanced approach imposed on them – somewhat disappointing – we will come back on this…

Page 12: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 12

B. REST OF THE WORLD

B.2 Time Frame

– Varying answers

– European banks generally target January 2008

– American authorities have postponed it by a year, January 2009

unless

– Are banks going to be ready? The vast majority will (confirmed by recent surveys)

– Timetable is set for Credit Risk. Gives Op. Risk implementation work ample time.

Page 13: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 13

B. REST OF THE WORLD

B.2 Time Frame (cont.)

Other factor:

– The most delicate implementation is for Advanced Banks. This is for the biggest banks that have more financial and human resources.

– There will be few exceptions.

– Banks that are falling behind with their credit implementation program will not get regulatory clearance for operational risk model.

– Few smaller banks that decided to aim for standardized despite their small size.

Page 14: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 14

B. REST OF THE WORLD

B.3 Role of Regulators and Market Pressure

– Influence of regulators; a delicate topic.

– American authorities’ decision in the public domain.

– Generally speaking, regulators probably low key for Op.Risk – not the case for Credit.

– Large European banks felt strong market pressure.

– No pressure for smaller banks, yet…

Page 15: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 15

C. PROS AND CONS OF EACH APPROACH Views of a professional Op. Risk Manager on the 3 approaches

C.1 Basic Approach

– Major impact being increased of regulatory capital may be significant. Even the most sophisticated of them, with economic capital model, were probably carrying less than 15% for Op. Risk.

– Impact on competitiveness.

Page 16: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 16

C. PROS AND CONS OF EACH APPROACH

C.2 Standardized Approach – manages the risk

What it does:

– Prior to Basle II, Op. Risk was intuitive;

– After Basle II, Standardized approach will make them better risk managers.

Feature:

– Separate risk discipline;

– Transparent and disciplined;

– Consistent across all business lines.

Page 17: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 17

C. PROS AND CONS OF EACH APPROACH

C.2 Standardized Approach – manages the risk (cont.)

– Standardized model provides for capital to be calculated by multiplying Beta 12, 15 or 18% and gross income.

– Resulting capital hardly risk sensitive and delivers little benefits.

– Main benefit comes by implementing risk management framework:

• Op. Risk governance;

• Loss data collection;

• RCSA Program;

• Risk indicators.

Page 18: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 18

C. PROS AND CONS OF EACH APPROACH

C.2 Standardized Approach – manages the risk (cont.)

– Loss data collection• Increases awareness (specially for low impact)• Creates a demand for forward looking tools

– RCSA Program : BU managers• Assesses risks• Evaluates adequacy of controls• Implements action plans

– Risk indicators• Monitoring tool operating on continuous basis• Not necessarily accurate but directionally correct

– KRT • Supposed to offer capability to set risk limit or tolerances.

More work needed to demonstrate predictability and correlation.

Page 19: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 19

C. PROS AND CONS OF EACH APPROACH

C.2 Standardized Approach – manages the risk What it does…

Not only better management. Two other features:

– Decentralized : unlike Credit and Market Risk

• Central unit, define and design. No limit setting.

• BU implements, assumes ownership.

– Risk based : concentrates on important risks

• Op.Risk is everywhere.

• Most risks minor and frequently prohibitive to eliminate.

• BU are very good at addressing important risk.

Page 20: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 20

C. PROS AND CONS OF EACH APPROACH

C.2 Standardized Approach – manages the risk What it does… (cont.)

– BU don’t do it for the regulators.

– Respond to their needs.

– Value creation.

– Very different from other compliance work which is viewed as unproductive and cost of doing business.

Page 21: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 21

C. PROS AND CONS OF EACH APPROACH

C.2 Standardized Approach – manages the risk What it doesn’t do…

– No objective tools to set Op. Risk limit. Limit setting either reactive or subjective.

– Because:• Method requirements vague and unclear;

• KRI still primitive.

– Major Negative:• Capital calculation hardly risk sensitive;

• Might not produce a lower amount of capital than Basic;

• May produce irrational behaviour.

Page 22: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 22

C. PROS AND CONS OF EACH APPROACH

C.2 Standardized Approach – manages the risk What it doesn’t do… (cont.)

Conclusion:

– Brings better risk management;

– Contributes to value creation;

– Does not necessarily deliver lower capital – which should be expected from better management.

Page 23: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 23

C. PROS AND CONS OF EACH APPROACH

C.3 Advanced Approach – measures the risk What it does…

– Good management from Standardized.

– Requirement more demanding: aiming at better integrating management and measurement.

– Big plus is efforts to better measure capital requirement in a more risk sensitive manner.

– LDA provides for capital being determined by unexpected loss for each risk type.

Page 24: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 24

C. PROS AND CONS OF EACH APPROACH

C.3 Advanced Approach – measures the risk What it does… (cont.)

– You need to understand your severity distribution and impact distribution for each risk type.

– Results is regulatory capital by risk type and BU.

– This creates risk management possibilities:• Charging capital to businesses;

• Limiting capital to certain business lines.

– Another benefit is clearly capital reduction which is a very strong attraction to this method.

Page 25: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 25

C. PROS AND CONS OF EACH APPROACH

C.3 Advanced Approach – measures the risk What it doesn’t do…

– Scepticism amongst community of professional Op. Risk Managers.

– Explains why several large banks like HSBC are not implementing it, at least for now.

– The general view is that most of the benefits from better risk management comes with Standardized and to walk the extra mile for Advanced requires more assurance of capital reduction.

– No banks internal loss database contains the data required to estimate tail end of loss distribution.

Page 26: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 26

C. PROS AND CONS OF EACH APPROACH

C.3 Advanced Approach – measures the risk What it doesn’t do… (cont.)

– Regulators knew it but, to encourage banks to go Advanced, proposed means of filling the gaps.

– Scenario analysis : external loss database.

– Work is being done to make these processes more robust.

– Major obstacle not regulators but CFOs. Even if regulatory capital decreases, real capital will not.

Page 27: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

THIRD INTERNATIONAL CONFERENCE ON CREDIT AND OPERATIONAL RISK April 13, 2007 - by Denis Pellerin, Senior Vice-President – Operational and Market Risk Management 27

C. PROS AND CONS OF EACH APPROACH

C.3 Advanced Approach – measures the risk What it doesn’t do… (cont.)

Conclusion

– Advanced approach has great potential to bring to Op. Risk managers a really risk sensitive approach.

– In the short term, the availability of data is an important obstacle.

– I suggest that this be addressed progressively and, eventually, as internal loss database becomes more reliable, more banks will move to Advanced.

Page 28: Are Banks Ready for Basle II and what are they preparing for… Operational Risk Denis Pellerin Senior Vice-President Operational and Market Risk Management

Thank you!


Recommended