Basel IV - Operational Risk SMA finalized

The final design of the new Basel IV: Standardized Measurement Approach (SMA) is less conservative than previous version presented in the consultation paper. This means that the impact on capital requirements will be less severe. However, extreme cases of capital increase are still possible.

What defines SMA?

SMA consists of two components: Business Indicator Component (BIC) and Internal Loss multiplier (ILM). BIC and ILM are multiplied in order to obtain the operational risk capital requirement.

Changes in BIC

Where: ILDC – Interest, Lease and Dividend Component

            SC – Service Component

            FC –  Financial Component

• The number of buckets in which banks are classified according to BIC has been reduced from five to three. Bucket 1 – below 1 BN EUR, Bucket 2 – between 1 – 30 BN EUR, Bucket 3 – above 30 BN EUR.
• The threshold from bucket 1 to bucket 2 remains unchanged at 1 billion euros. Threshold from bucket 2 to bucket 3 amounts to 30 billion euros.
• Weighting of BIC for the three buckets has been heavily adjusted. For bucket 1 it has increased from 11% à 12%. Weightings for bucket 2 & 3 have been greatly reduced. Bucket 2 BIC is weighted at 15%, while bucket 3 has a weight of 18% (compared to 29% in the consultation paper).
• The service component (SC) integrated in BIC has been simplified.
• The financial component (FC) of BIC is slightly modified.

Changes in ILM

Parameters of ILM were adjusted. The final version of ILM is:

• Average losses are weighted less in the loss multiplier due to the 0.8 exponent. The reduction of capital requirements for banks with below-average total losses is lower.
• The weighting of losses on the amount of losses is eliminated. All losses from past operational risk events are considered equal in the loss multiplier, regardless of individual loss amount.

National legislators options

• Decide if loss multiplier is applied for Bucket 1 banks, provided the banks meet the requirements for loss data collection.
• Suspend the use of loss multiplier for all banks, even if they are classified to buckets 2 or 3. Disclosures regarding loss data are mandatory for banks even if they only use BIC to determine capital requirements for operational risk.
• Request a conservative loss multiplier ILM > 1 if the bank doesn’t meet the quality requirements for loss data and data collection.

BCBS simulation of capital impact

The BCBS used a sample of 150 banks (28 are G-SIBs) to simulate the impact in minimum capital requirements. Banks were grouped in three categories: G-SIBs, large and small. The results of the analysis are the following:

v  The median capital impact for G-SIBs and large banks is -3%, while for small banks is 0.6%.

v  In extreme cases, capital requirements will increase by 300% for large banks, 225% for G-SIBs and 240% for small banks. The other extreme being a decrease of -75% for large banks and G-SIBs, -80% for small banks.

How can Deloitte help?

v  Assist in SMA implementation in order to be prepared for January 1 2022 deadline.

v  Timely trail calculation of operational risk capital requirements to be prepared if impact is extreme.

v  Simulation of the effect of applying SMA on your bank to better prepare your capital agenda.