PHILIPPINE BANKS must now account for their past losses in computing their operational risk capital as the Bangko Sentral ng Pilipinas (BSP) adopted a new approach to align the industry’s capital and prudential requirements with global standards.
In a statement late on Tuesday, the central bank said it has now adopted the Basel III New Standardized Approach (NSA) for computing capital charges regarding operational risk, replacing the existing basic indicator approach and standardized approach.
“The Bangko Sentral ng Pilipinas has adopted the Basel III New Standardized Approach for determining the capital that banks must hold to absorb unexpected losses from operational risk,” the central bank said. “The adoption is expected to strengthen banks’ resilience and align BSP’s risk-based capital adequacy framework with international standards.”
The BSP has introduced amendments to its Manual of Regulation for Banks, mandating lenders to disclose their operational risk-weighted assets, operational loss events, and excluded divested activities in their annual reports.
Under the Basel III’s NSA, universal, commercial and digital banks, and their subsidiary banks or quasi-banks must combine their historical operational loss experience with their financial size in computing their operational risk capital.
According to the BSP, operational risks refer to potential losses from inadequate or failed internal processes, people, systems, or from external events. These include cyberattacks, fraud, human error, technology failures, and natural disasters.
Banks are currently following the basic indicator approach or the standardized approach in calculating their operational risk capital charge (ORCC).
The basic indicator approach requires them to hold an operational risk capital equivalent to 15% of their average gross income over the past three years of positive annual gross income.
The standardized approach computes the ORCC as the three-year average of the simple summation of the regulatory capital charges across each of the business lines every year.
On the other hand, under the NSA, banks must compute their ORCC by multiplying their business indicator component and internal loss multiplier (ILM). Banks’ operational risk-weighted assets are then computed as the ORCC multiplied by 10.
Based on the circular, internal loss databases must cover a 10-year period and adhere to the regulator’s identification, collection, and treatment criteria.
Banks that do not meet the BSP’s criteria for managing internal loss data must apply a default ILM of one. However, the central bank may require an ILM above one if a bank has material control deficiencies affecting its loss data or if warranted for supervisory enforcement actions.
“The NSA is more risk-sensitive because it allows capital requirements to better reflect a bank’s operational risk profile by considering its income and historical operational loss experience,” the central bank noted.
“This approach also encourages implementation of stronger operational risk management system and the development of a robust historical loss database,” it added.
Based on the new framework, the business indicator is a financial statement-based substitute for operational risk.
Instead of using overall gross income, the NSA computes the business indicator as the three-year sum of banks’ interest, leases, and dividend component; service component, which includes fee income and expense and other income and expenses; and financial component or the sum of the absolute value of banks’ net profit and loss from both their trading and banking books.
“At the consolidated level, the NSA calculation shall use consolidated business indicator figures, which net all the intragroup income and expenses. Where the parent bank complies with the internal loss data requirements, the consolidated ORCC shall be based on the group’s consolidated loss experience and the resulting ILM,” the BSP said in a separate circular signed by BSP Governor Eli M. Remolona, Jr.
“At the solo level, the covered financial institution shall use its own business indicator figures and loss experience in calculating BI (business indicator), LC (loss component), and ORCC,” it added.
For banks undergoing mergers or acquisitions, the circular mandates including the BI items of the merged or acquired business over the three-year period before the transaction date into the surviving bank’s BI calculation immediately after the merger or acquisition, subject to the BSP’s post-verification.
Meanwhile, the BSP allows covered institutions to request approval to exclude historical operational loss events from their loss database if they are no longer relevant to the bank’s risk profile.
However, such exclusions must be rare, strongly justified, and evaluated on “whether the cause of the loss event could occur in other areas of the financial institution’s operations.”
At the same time, banks may also request from the BSP to exclude divested activities from their BI computation, provided all approved exclusions are fully disclosed in their annual reports and published financial statements.
Once the circular takes effect, covered banks will be under a monitoring period wherein they must submit parallel capital adequacy ratio (CAR) reports using both the old Basic Indicator Approach or Standardized Approach and the new Basel III NSA.
Banks may apply for early adoption during the monitoring period subject to prior notification to the central bank and supervisory post-verification.
According to the BSP, the start date and reporting details of this monitoring phase will be announced in a separate issuance, but the full implementation of the NSA-based quarterly CAR reports will begin at the end-December 2027 reporting period.
The NSA is part of the Basel III reforms which were introduced by the Basel Committee on Banking Supervision in December 2010 and later finalized in December 2017. — Katherine K. Chan