H.R. 4296 restricts banking regulators from establishing operational risk capital requirements (the amount of money and non-cash assets banks are required to hold in reserve) for banking organizations unless they:
- Are sensitive to, and based on, an organization’s current activities or businesses;
- Are determined by a forward-looking assessment of an organization’s potential losses and not based solely on its historic losses; and
- Allow for adjustments based on qualifying operational risk mitigants.
In response to the 2008 financial crisis, the Basel Committee on Banking Supervision (Basel Committee) agreed to modify internationally negotiated bank regulatory standards known as the Basel Accords to increase bank capital requirements. The Basel Accords are international banking regulations negotiated between participating regulators, but they rely on local implementation to take effect in a nation’s financial regulatory regime. In the United States, the Federal Deposit Insurance Corporation (FDIC), with input from the Federal Reserve and Office of the Comptroller of the Currency (OCC), determine domestic capital requirements that follow the Basel framework.
As defined by the Basel Committee, operational risk refers to “…the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events...[t]his definition includes legal risk, but excludes strategic and reputational risk.” In other words, a bank’s own direct actions or relationships could lead to losses, and therefore should be accounted for by regulators when they seek to establish capital requirements to ensure financial stability.
In developing one such standard, known as the operational risk capital framework, the Basel Committee suggested that banks review a banking organization’s existing business operations as a representation of its future capital needs..
While all banking organizations should adopt policies and procedures to identify and manage operational risk that are appropriate based on their size, activities, and product offerings in order to ensure a stable and resilient financial industry, requiring them to “look back” and hold operational risk capital against discontinued business activities or products is not an appropriate way to determine capital requirements. The result of forcing banks to look back and hold capital against discontinued activities and products is harm to consumers through drastically reduced credit availability in the marketplace.
Because operational risk capital requirements substantially dictate a bank’s capital levels, it is important that any future Basel approach-turned-U.S. rule does not unnecessarily increase capital requirements at the expense of consumers’ credit needs. Unreliable and under-calibrated calculations could result in hundreds of billions of dollars in capital that could be more efficiently deployed to meet consumers’ credit needs.
As such, H.R. 4296 limits the imposition of operational risk capital requirements to a bank’s current activities and businesses and permits adjustments to mitigate operational risk. By instituting clear guardrails, this legislation ensures the imposition of forward-looking capital requirements that focus on a bank's current activities and businesses. Doing so will ensure that banks are holding more capital more efficiently, and expands the credit marketplace to meet consumer needs. This also incentivizes institutions to mitigate operational risk, which creates safer banks and a resilient financial system.