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Nematrian Reference Library

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Introduction (beginning) "Since the first Basel Accord was adopted in 1978, the banking sector has been persistently complaining about the simplistic approach of risk-adjusted credit exposures based on the adoption of the Cooke ratio for the determination of economic capital. The arbitrary categorization of securities in broad risk classes was allegedly leading to overly conservative and/or inadequate capital charges. Therefore, many large institutions have developed their own proprietary model for credit and market risk exposure with the objective of convincing their corresponding regulator of the superiority of their "Internal Rating Based" approach over the Basel I standards. The need for organizing the framework under which the IRB approach is eligible to measure banks' exposures to credit risk is probably the main impetus for the revision of this system through the second Accord. Yet, the Basel Committee on Banking Supervision (hereafter the Basel Committee) has also taken this opportunity to extend the scope of its proposals well beyond this emblematic issue. In particular, the new Accord introduces and thoroughly examines a type of risk which, although well documented in the manufacturing sector, had been somewhat overlooked by the banking industry until recently: that is, operational risk, defined by the New Accord on Capital Adequacy proposal (hereafter Basel II) as the “risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events” (BCBS, 2003a)."

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