Corporate Governance in Banking
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Corporate Governance in Banking

A Global Perspective

Edited by Benton E. Gup

Recent corporate scandals, together with the effects of globalization, have led to an increasing interest in corporate governance issues. Little attention has been paid, however, to international laws and recommendations dealing with corporate governance in banking from a global perspective. This impressive international set of expert contributors – academics, practitioners and regulators – remedies the lack of attention by examining the various issues and concerns of this important topic.
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Chapter 7: Basel II: Operational Risk and Corporate Culture

Benton E. Gup


Benton E. Gup BASEL II The New Basel Capital Accord (hereafter called Basel II) replaces the 1988 Capital Accord (Basel I). Whereas Basel I has a simple one size fits all 8 percent capital standard for banks, Basel II is very complex; and is targeted primarily at large complex financial organizations (LCFOs). By definition, LCFOs are internationally active. ABN-Amro, Citigroup, and HSBC are examples of LCFOs. The major difference between the two capital accords is that Basel II provides for more flexibility and risk sensitivity than Basel I ‘to promote adequate capitalization of banks and to encourage improvements in risk management’. Basel II1 consists of three mutually reinforcing pillars: Pillar 1– minimum capital requirements, Pillar 2 – supervisory review process, and Pillar 3 – market discipline. As shown in Equation 7.1, Pillar 1 retains the current definition of capital and the minimum 8 percent requirement in the numerator. In the denominator, the measures for credit risk are more complex than Basel I, market risk is the same, and operational risk is new. This chapter focuses on operational risk. Total Capital (definition unchanged) Ն 8% maximum Credit risk ϩ Market risk ϩ Operational risk capital ratio (7.1) The United States, will have a ‘bifurcated regulatory capital framework’, where the rules involving advanced measures of credit risk and operational risk will only apply to about ten LCFOs. Other banking organizations can ‘opt in’ to applying the new rules, while the remaining banks will continue to apply the existing capital rules.2 The affected LCFO...

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