DFSA - CP164: Operational Risk Capital Requirement under Basel III

The Riffle

The DFSA Consultation Paper CP164 addresses the Operational Risk Capital Requirement under Basel III, aiming to align Dubai Financial Services Authority's (DFSA) prudential regulations with international standards. The paper proposes transitioning from Basel II's Basic Indicator and Alternative Standardised Approach to Basel III's Revised Standardised Approach (RSA). This move enhances risk sensitivity by replacing gross income-based calculations with a Business Indicator (BI) and Marginal Coefficient. The implementation is proposed for July 1, 2026, with public consultation open until May 12, 2025.

Key Findings & Proposals

1. Transition to Basel III Revised Standardised Approach (RSA)

   • The DFSA seeks to replace Basel II's outdated methods with the risk-sensitive RSA.

   • The Business Indicator (BI), a new risk measure, incorporates financial components like interest, leases, and dividends.

2. Calculation of Operational Risk RWA

   • Formula: Operational Risk RWA = 12.5 × Business Indicator × Marginal Coefficient.

   • BI is computed as a three-year average of financial data, and the Marginal Coefficient is applied in a tiered manner based on firm size.

3. Neutralisation of the Internal Loss Multiplier (ILM)

   • The DFSA will not implement the ILM, which adjusts capital based on past losses.

   • The rationale includes loss unpredictability, lack of standardised loss data, and global regulatory trends.

4. Redefinition of Operational Risk

   • The DFSA aligns with Basel III’s definition, covering failed processes, systems, and external events, including legal risk but excluding strategic and reputational risks.

5. Scope of Application

   • Applies to firms under the Basel regime, including deposit-taking institutions, credit providers, investment dealers, and Islamic financial institutions.

6. Implementation Timeline & Next Steps

   • Proposed implementation: July 1, 2026.

   • Stakeholder feedback is invited until May 12, 2025.

The DFSA’s proposed transition to Basel III’s RSA reflects a global shift towards more robust and risk-sensitivecapital requirements for operational risk. The neutralisation of ILM aligns with other global regulators, and the new definition of operational risk ensures clarity. With a 2026 implementation timeline, financial institutions in the DIFC must prepare for compliance, and stakeholders are encouraged to participate in the consultation process.

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