At the beginning of this year, the Basel Committee on Banking Supervision issued proposals to drastically revise the 1988 Capital Accord, the rules which govern the supervisory approach to banking capital. The new Basel Capital Accord, originally to be implemented in 2004 and now extended to 2005, is based around three pillars: minimum capital requirements; supervisory review; and market discipline. Introducing the proposals in January, William J McDonough, Chairman of the Basel Committee and CEO of the Federal Reserve Bank of New York, commented, “The new framework is intended to align regulatory capital requirements more closely with underlying risks, and to provide banks and their supervisors with several options for the assessment of capital adequacy.”
In Pillar 1, the Basel Committee aims to replace the 1988 Accord's ‘one size fits all' approach to minimum capital requirements with several options, the choice of which depends on the complexity of the bank's business and the quality of its risk management. A bank's choice of minimum capital requirement options will require authorisation by the local supervisor. On the credit risk side, a standardised approach was proposed for less complex banks, while those with advanced risk management capabilities would be allowed to use an internal ratings-based approach. The proposals include flexible capital requirements that change depending upon an individual bank's risk profile.
Pillar 2 proposes new procedures enabling supervisors to ensure that each bank has ‘sound internal processes' to calculate capital adequacy, and to set targets for capital.
New disclosure requirements and recommendations are intrinsic to Pillar 3, covering capital structure, risk exposures and capital adequacy.
Initial responses to the consultative documents were generally positive, though criticisms were levelled that it still could result in uneven playing fields. Patrick Maughan of Belgian consultancy Flux noted in particular the inclusion of capital adequacy for operational risk in the proposed Accord. “At this stage, we can only say that if the Committee does not accept that appropriate insurance cover is a mitigating factor in (capital adequacy) requirements for operational risk, this can only have a detrimental effect on financial lines insurance generally.”
Among the comments received by the Basel Committee before its end May deadline were several from the re/insurance industry. Individual submissions were sent in from brokers Marsh and Willis, as well as insurers AIG Europe and R&V Allgemeine Versicherung AG. Probably the highest level submission was from the Property & Casualty Insurance Industry Working Group, a veritable Who's Who of the industry comprising: Michael O'Halleran, president and COO of Aon; Benito Pagnanelli, deputy general manager and chief executive of Generali Global; Thomas Bolt, managing director of the European division of Berkshire Hathaway Insurance Group; Dean O'Hare, chairman and CEO of Chubb; Willhelm Zeller, chairman of the executive board of Hannover Re; Stefan Heyd and Thomas Wollstein, member of board and member of executive management respectively of Munich Re; Stephen Burnhope, group executive director at SVB Syndicates; Dr Erwin Zimmermann, member of the executive board of Swiss Re; Koukei Higuchi, president of Tokio Marine & Fire; Brian O'Hara, president and CEO of XL Capital; Hirosho Hirano, president and CEO of Yasuda Fire & Marine; Thomas Kaiser, CEO and member of the group management board of Zurich Corporate Solutions; and Rene Manser, senior vice president at Zurich IC Squared.
The group's response asserts that the property/casualty industry is a suitable counterparty for operational risk transfer, able to reduce banks' systemic risk because:
Operational risk cover currently is being provided by the insurance industry to the banking sector through all-risk property, general liability, bankers blanket bond, D&O, E&O and employment practices liability policies, and insureds with good risk management and control structures benefit from better terms than weaker institutions.
The group makes three recommendations to the Committee:
1) properly structured and soundly underwritten insurance provided by financially sound insurers should receive credit against the operational risk calculation;
2) data collection and sharing will be a critical component for calculating the operational risk capital charge and expanding insurance market coverage of operational risk, so the insurance and banking industry should work together to enhance current data-collecting and sharing mechanisms and to develop new ones; and
3) technical groups should be established to work with banks to clarify common loss definitions, methodologies, data pooling, claims settlement mechanisms and determine the precise methodology to calculate capital relief.
In its statement following the end of the consultation period, the Basel Committee said it was considering “numerous” comments and suggestions related to operational risk. In addition, it has modified the timetable, adding in another round of consultation in early 2002 with the aim of finalising the new Accord during the year. If the proposals put forward by the P&C Insurance Industry Working Group are adopted, they could lead to increased product development as the two sectors work closer together, at the same time providing an external review of banks' control procedures and risk management cultures.