OPERA^® Basel II — Wealth Management Capital Allocation Case Study

Initial Analysis
In tackling the Basel II wealth management assignment, BPG started by revisiting the goals of the Basel II guidelines and the requirements defined by the bank's Basel II Implementation team. Senior management wanted to know:

• The overall impact of applying Basel II's credit, market and operational risk requirements to the wealth management group;
• The organizational activities, processes, applications and reporting that would be affected; and
• The sources and method of acquiring information from internal systems and processes for on-going capital requirements assessment and reporting.

BPG cautioned the team and the bank's executives that based upon past experience, the commonly accepted analysis of credit, market and operational risks were unlikely to provide an accurate assessment of capital allocation for the group.

BPG recommended a structured approach to assess the potential overlap in the ongoing processing in a way that;

1. Segmented credit risk between credit exposure assumed by the bank and credit exposure assumed by non-bank entities (e.g., fully-disclosed broker arrangements);
2. Differentiated between market risk where the bank was a principal in the transaction and where the bank was acting in a custodian, trust, fiduciary, investment management or broker capacity;
3. Highlighted current, on-going operational process risk indicators to dramatically improve the then current "after-to-fact" operational risk loss tracking.

BPG based its guidance and approach on the fact that the bank had sophisticated processes in-place for determining capital allocations under the current regulations and had passed all internal and external audit and regulatory reviews.

BPG's experience with standard risk controls and actuarial loss measurements show they are measurement frameworks well suited for credit and market risk purposes but unlikely to benefit management analysis when assessing operational capital requirements. The mix of classic bank and non-bank operations further complicated understanding and confused the analysis.

With this perspective in mind, the team started with an analysis of the functions performed by the wealth management group. Each function was classified as into a traditional regulated 'Bank' or non-traditional 'Banc' activity.

The group's 'Bank' activities were then analyzed to determine where capital allocation was captured in the current regulatory process, whether the credit risk allocation would it would remain the same under the new Basel II requirements and where the new operational risk requirements should reside in the future.

The 'Banc' activities were analyzed to determine how the new requirements impact the categorization on non-traditional bank activities, as well as changes in the overall process of capital allocation analysis and reporting.

To identify how the organization of people, process and systems within the wealth management group might give rise to the type of unexpected losses for which the bank was expected to allocate capital, BPG led the team in an analysis of it's 'Banc' activities on credit and market risk. Activities such as securities and margin lending were carefully examined to understand the bank's exposure under a number of different potential market scenarios.

This approach added a discipline and framework for decision making to the team's analytic efforts and thought process. The approach forced a focus on the logic used to categorize, assess and assign risks that could potentially exist in the many components of the bank's wealth management infrastructure. Further the approach involved the team in establishing the specific methods to verify group's credit, market and operational risk.

The project's analysis phase included analysis and line of business impacts including the appropriateness and completeness of the data from the banks mutual fund, investment management, trust, custody and retail brokerage systems.

Through a series of straightforward analytic steps, directed by BPG staff, team personnel were able to verify expected outcomes, quickly recognizing and isolating potential loss events using data from the bank's recordkeeping and reporting systems. Grouping these risks by process, functional and investment categories the team was able create a multi-dimensional view of the impact each had on the bank's capital requirements.

Next: Implementation

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