BSP to require banks to provide capital cover for operational risks

The Bangko Sentral ng Pilipinas (BSP) will soon require banks to provide capital cover for operational risks, a new concept that will align the country’s banking practices with the International Accounting Standards (IAS).

The BSP is now drafting the rules that will govern the operational risks of banks, making distinctions between prudent banks and banks that engage in high-risk businesses.

Banks are required to provide capital cover for their banking activities, depending on how risky these activities are, whether loans or investments.

According to BSP assistant governor Nestor Espenilla, the BSP will soon introduce the concept of operational risks, reflecting the efficiency of the bank as well as its internal checks and balances.

"The most common risk is failure to pay," Espenilla said. "But sometimes the failure of banks can be due to operational factors–their computer system could collapse, there could be internal fraud, or even robbery."

Espenilla said the BSP wants banks to provide the capital cover for such operational risks, a requirement that would compel banks to tighten up their operations to head off operations-related failure.

"We believe there should be a capital cover for operational risks as well," Espenilla said. "The assignment of risk classification will be based on the risks the banks are taking and there will be different grades of capital cover requirements."

Espenilla said it is unfair for prudent banks to be classified the same way risky banks are classified since the former is taking extra steps to minimize operational risks while the latter is not.

The BSP has been moving towards risk-based regulation of banks, recently increasing the risk-weighting of the non-performing exposures of banks and then lowering the capital charge for high-quality credits.

The Monetary Board approved the new circular that allows for greater risk sensitivity in the existing bank capital adequacy framework.

Espenilla said the assignment of operational risk classification would be applied in the same manner and the BSP would draw the criteria based on international best practice.

Thus far, the BSP has reduced the minimum capital charge for high-quality credit from 10 percent to only two percent through a reduction in their assigned risk weight.

This so-called high quality credit refers to banks’ holdings of corporate debt securities and loans to companies which are considered of high quality, rated at least "AA-" or its equivalent by BSP-accredited credit rating agencies.

On the other hand, the BSP said it is increasing the minimum capital charge for non-performing loans from 10 percent to 15 percent through an increase in assigned risk weight.

By 2007, the minimum would be adjusted to the full 15 percent and non-performing debt securities would also be treated similarly.

However, the BSP said it is making a distinction for non-performing housing loans by increasing the minimum capital charge from five percent to 7.5 percent by end 2006 and finally to 10 percent by 2007.

"The minimum capital charge for non-performing housing loans will be significantly lower than ordinary NPLs because we are giving preferential treatment for housing loans which are considered to be of relatively lower risk," the BSP explained.