Abstract
Basel II introduced a three pillar approach which concentrated upon new capital ratios (Pillar I), new supervisory procedures (Pillar II) and demanded better overall disclosure to ensure effective market discipline and transparency. Importantly, it introduced operational risk as a standalone area of the bank which for the first time was required to be measured, managed and capital allocated to calculated operational risks. Concurrently, Solvency II regulation in the insurance industry was also re-imagining regulations within the insurance industry and also developing operational risk measures. Given that Basel II was first published in 2004 and Solvency II was set to go live in January 2014. This paper analyses the strategic challenges of Basel II in the UK banking sector and then uses the results to inform a survey of a major UK insurance provider. We report that the effectiveness of Basel II was based around: the reliance upon people for effective decision making; the importance of good training for empowerment of staff; the importance of Board level engagement; and an individual's own world view and perceptions influenced the adoption of an organizational risk culture. We then take the findings to inform a survey utilizing structural equation modelling to analyze risk reporting and escalation in a large UK insurance company. The results indicate that attitude and uncertainty significantly affect individual's intention to escalate operational risk and that if not recognized by insurance companies and regulators will hinder the effectiveness of Solvency II implementation.
Highlights
During the 1970s and 1980s the banking industry, in the UK and globally, experienced a sea change with regards to banking theory, practice and regulation
We extend our analysis based on our findings from Basel II implementation in the banking industry to examine the implementation of Solvency II in the insurance industry, which is often referred to as the Basel II for insurance companies
The key findings of this phase of the research are reported and inform the development of the second stage methodology — a survey undertaken at a large UK insurance company to help inform Solvency II implementation to which we received 111 (n = 111) completed responses
Summary
During the 1970s and 1980s the banking industry, in the UK and globally, experienced a sea change with regards to banking theory, practice and regulation. These changes can be traced back as far as the liberalization of the banking and financial markets throughout the 1970s and the encroachment on each other's traditional business lines during the early 1980s. From its implementation, Basel I was already considered inadequate to control for the changes occurring in bank operations in both its calculations of ‘capital adequacy’ and its ability overall to capture the right metrics to reduce risk within the industry. The Accord was amended to include market risk in 1996 and throughout the 1990s, the Basel Committee worked on introducing a replacement in the form of Basel II
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