(i) Add-on Based on Key Operational Ratios
A firm's operational risk will not necessarily bear any relationship to its market or credit risk. It would therefore make sense to move away from the market or credit risk calculations and calculate an operational risk capital charge related to data that somehow reflected the scale of this risk. Examples might be variability in earnings, turnover, staff costs (e.g. broken down between front and back office), staff turnover, error rates and technology costs.
- These numbers would have some relationship to operational risk e.g. a turnover to staff costs ratio that is "high" might indicate greater operational risk.
- It would use readily available management information.
- The operational risk buffer could be scaled according to the ratios.
- It could provide rewards for risk reducing behaviour.
- The methodology would require detailed research to establish benchmark ratios and how to convert any overshoot into a capital charge.
- All ratios have limitations due to a lack of consistency in their calculation and to difficulties in interpreting the outcome e.g. a high turnover to staff costs might indicate under-investment in staff or good management control.
(ii) Base Requirement
One approach would be to apply a base requirement reflecting the scale of a firm's activities to capture non-measurable risks (e.g. x% of fixed costs).
- Relates capital to size (which has some logic to it).
- There is not a straightline relationship between operational risk and size.
- Could be seen as a penalty on success.
- Can encourage firms to modify group structures to meet regulatory needs rather than their own risk management needs.