During the initial phase of Basel II implementation, the regulatory spotlight was primarily focused on those firms applying for AMA approval for operational risk ("OR") regulatory capital. It is, however, becoming apparent that in the wake of the recent high-profile operational risk losses incurred by institutions around the world, the FSA and other financial regulators are considering rolling out the "regulatory use test" to a wider audience of firms.

As a result, irrespective of whether a firm has opted for the simplest Basel II OR approach (i.e. the Basic Indicator Approach/BIA), one of the intermediate approaches (i.e. The Standardised Approach/TSA or Alternative Standardised Approach/ASA), or the most advanced approach (Advanced Measurement Approach/AMA), regulators are likely to place the OR culture and practices of the firm under considerable scrutiny, effectively "raising the bar" on regulatory compliance in this area. If it becomes apparent that that firm's OR framework is not satisfactory in the eyes of the regulator, the firm may be subject to an increased regulatory capital requirement at least until such time as the underlying issues have been addressed to the satisfaction of the regulator.

Increasing emphasis is being placed by regulators on firms' pro-active management of operational risk exposure. As a result, firms' adherence to the key qualitative standards of the use test will be as important as their compliance with the "quantitative" use test standards and is likely to be increasingly applied by the regulators in their assessment of the soundness of any firm's operational risk framework, regardless of the approach used for regulatory OR capital calculation.

Authors:

Simon Baker - Deputy Head of Consulting

Jennifer Györy - Senior Associate, Operational Risk and Non-banking Services