Twenty-three large, internationally active banks reported more than twice as many instances of major operational losses in 2003 than they had two years before, according to a study released by federal banking regulators.
The Loss Data Collection Exercise for Operational Risk, released late last week, sought to quantify the number and cost of losses from internal and external fraud, technology breakdowns, natural disasters, or other unforeseen events.
Banks participating in the study reported 16,080 operational losses of more than $10,000 in 2003, versus 2,079 in 1999 and 7,709 in 2001.
Including incidents that cost less than $10,000 each, they reported more than 1.5 million problems that cost $25.9 billion from 1999 through 2003.
The increase in major operational losses was largely attributable to the more detailed recording methods that agency officials had urged bankers to adopt in preparation for the Basel II capital rules. To qualify to use those rules, which are scheduled to go into effect in 2008, bankers must compile massive lists of incidents and losses, so they can adequately measure risk and hold capital as protection.
U.S. officials said Thursday in presentations to bankers and international regulators at a Federal Reserve Bank of Boston conference that there are still some significant problems with the data, because definitions and accounting methods vary among the banks. However, the officials said the data had become far more meaningful since 1999.
“The issues around data are very important when we talk about capital,” said Charles Taylor, the director of operational risk for the Risk Management Association. “Given where we were a year ago, I think we’re doing very well, but it’s quite clear that there remain issues about the quality of the data.”
But regulators still wanted to see more. Among other things, Patrick deFontnouvelle, an assistant vice president at the Boston Fed, said bankers were doing a poor job of recording how much of their operational losses were being recovered from insurance policies.
More accurate data could affect capital requirements, and a lack of data could keep regulators from letting a bank use the new capital standards.
Basel II, which has been in the works since 1998, is supposed to make banks’ calculations of credit and market risks more sensitive. It also would require banks for the first time to hold capital against operational risks.
For example, if a bank loses money because a technical glitch causes an automated teller machine network to go down, the loss would be considered an operational one. So would a loss from an internal fraud scheme. Some Florida banks reported operational losses when hurricanes forced them to temporarily close branches last year.
Three out of every five losses reported from 2002 to 2004 took place in the retail banking business line; the next most popular category — retail brokerage — generated just 7.3% of the losses. The corporate finance category accounted for the fewest losses (0.3%), but each of the losses were generally more severe than those in other categories.
Federal Reserve Board Governor Susan S. Bies told reporters that the measurement of operational losses is less sophisticated than the measurement of credit, market, and interest rate losses.
“Operational risk has never really been the No. 1 focus of an institution,” she said. “We focus on interest rate risk, and we focus on credit risk, because those are the ones that can sink an institution.”
But regulators have pushed bankers to pay more attention to operational risk, because banks get more of their income from fee-based businesses that rely on properly functioning services and systems, Ms. Bies said.
“The evolution is occurring because the nature of banking itself has changed,” she said.
Despite visible differences in preparedness, regulators said they would continue letting each institution use its own data collection methodology, as long as the methodology is effective.
“What we’ve tried to do as regulators is refrain ourselves from putting a straight jacket on development,” said Roger Cole, a senior associate director at the Fed and one of Basel II’s main architects.
The Boston conference was the first major gathering of bankers and regulators since the agencies announced April 29 that they were postponing a proposed rule to implement Basel II because data for credit and market risk collected for another study showed a wide range of issues.
