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The major challenge in the internal capital adequacy assessment is to identify and accurately assess the significance of all of the risks faced by a bank and which may have consequences as regards to its financial situation. Subsequently, the risks identified, must be quantified by translating these into a capital requirement.
In all of these stages there are both conceptual difficulties and measurement problems. These include:
1.
What constitutes a relevant risk?
2.
What is the reasonable possibility that such a risk will actually happen?
3.
If such a risk occurs, how large is the damage that it might lead to?
4.
Do various risks arise independently or are they co-related with each other?
5.
How is the assessed risk to be priced in terms of capital requirements?
While there have been developments for analyzing and measuring risks, assessment and risk management are not an exact science in which models and systems automatically provide quantified answers. Analysis, assumptions, methods and models are important tools in order to obtain reasonable answers. However, ultimately, a comprehensive and prudent assessment is required which includes experiences, expert judgment and views other than those that can be formulated in figures. Sound common sense can never be replaced by statistics and model calculations.
There is also a strong linkage between the degree of sophistication with respect to risk measurement and management and the scope and nature of the bank's operations. For example, an international banking group with a large number of business areas and thus a complex risk structure has a need and the resources for a more advanced risk measurement methodology. However, for a small bank this may not be the case. Also, from a systemic risk perspective, more stringent requirements are obviously imposed on a large financial group since deficient risk management in such a bank may have detrimental impact on the entire financial system.
Given that banks are different is an important reason why SAMA will not prescribe any standard arrangement as to how the internal capital adequacy assessment process is to be carried out. It is up to each bank, based on its own operations, its scope of business and risks to formulate an internal capital adequacy assessment process which is suitably adapted and which meets the requirements of SAMA. This means also that the size of the operations is not the sole criterion; rather, it is the complexity and risk level of the operations which should be the main driver.
