Op risk capital charge will not hurt specialist banks
WASHINGTON - Large US banks chiefly involved in specialised activities, such as securities custody, payment processing and asset management, will not be badly disadvantaged by the proposed operational risk capital charge, despite claims to the contrary.
This is the conclusion of a study undertaken by the Federal Reserve Bank of Boston, which examines the likely impact on such specialist banks of the op risk capital charge required under the new Basel capital accord - Basel II - due to take effect in the US in 2008.
The four members of the Boston Fed's staff who undertook the study,* published in January, conclude: "Overall, the information we present suggests that the competitive effects of the Basel II capital risk charge will be, at most, extremely modest." The study is the third in a series of five White Papers that the Federal Reserve is preparing on aspects of the new capital regime for banks.
A few specialised banks have campaigned to have the explicit new op risk capital charge scrapped (under the existing Basel I accord it is an implicit element in the total capital requirement). They argue that large banks with substantial lending portfolios will be able to offset an op risk charge against a lower credit risk capital requirement. But, for specialised banks, the op risk charge will be a large additional burden. And, they will be at a competitive disadvantage against non-banks in the same specialised business, which will not have to face an op risk capital requirement, they say (see next story).
The study's authors focus on three markets where specialised banks (or "processing" banks, as the study calls them) have concentrated their activities: securities custody, asset management and payment processing. Among the largest 50 US banks, the study distinguishes four, in particular, with a high share of income from such activities and a relatively small loan portfolio: State Street, Mellon Financial, Northern Trust and the Bank of New York.
In custody, the study finds, the main competitors of the processing banks are other banks "almost all of which are expected to face an operational risk charge under Basel II." In processing, many non-bank competitors display a minimal degree of financial leverage, "and, thus, appear to have higher capital levels than the processing banks would be required to have under Basel II." Finally, in asset management, many competitors are expected to face Basel II-based capital charges for operational risk, or already have much higher capital ratios than the processing banks.
"We also note," say the study authors, "that the US processing banks generally hold significant capital buffers in excess of regulatory capital requirements, so that any increase in minimum regulatory capital may not necessarily lead to an increase in actual total capital held".
The results of the study suggest that the processing banks would be able to align regulatory capital with levels indicated by their internal models without raising additional capital, the authors say. In fact, the amount of capital actually held by processing banks - either because of market or rating agencies' demands or because of their own internal risk evaluations - suggests that these institutions may already be holding capital for operational risk, they add.
The study has drawn criticism, however, from supporters' of the processing banks' case. Critics have seized on a caveat in the study, where its authors admit that "detailed and comprehensive data regarding these markets and the relevant firms are difficult to come by. Much of our analysis is thus more narrative than empirical, and should be interpreted accordingly."
*The Potential Impact of Explicit Basel II Operational Risk Capital Charges on the Competitive Environment of Processing Banks in the United States.
