Over-estimation of the Basel III Endgame Operational Risk Capital Requirements

Introduction

Basel III Endgame (B3E), the proposed new bank capital standards that will apply to banks with $100 billion or more in total assets, impose an entirely new approach to computing capital charges and risk-weighted assets associated with operational risk.

These new capital standards on operational risk are estimated to increase risk-weighted assets (RWA) for large banks (Category I and II banks) by $1.4 trillion and $550 billion for smaller banks (Category III and IV banks). These operational risk requirements represent the bulk of the increase in RWA due to B3E.

As discussed in a companion piece, the proposed standardized approach for operational risk (SA-OR) is inherently flawed methodologically. Its deficiencies are further compounded by the fact that the existing stress capital buffer (SCB), which is a major component of minimum required capital calculations, already includes a component for operational risk under a severely adverse scenario in the annual bank stress test exercise. This “blending” of regulatory capital and stress tests likely leads to an excessive amount of required capital for operational risk.

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