operational risk hullrmfich14

8/7/2019 Operational Risk HullRMFICh14

1/14

11

Operational RiskOperational Risk


2/14

22

Definition of Operational RiskDefinition of Operational Risk

Operational risk is the risk of lossOperational risk is the risk of lossresulting from inadequate or failed internalresulting from inadequate or failed internal

processes, people, and systems, or fromprocesses, people, and systems, or fromexternal eventsexternal events

Basel Committee Jan 2001Basel Committee Jan 2001


3/14

33

What It IncludesWhat It Includes

The definition includes people risks,The definition includes people risks,technology and processing risks, physicaltechnology and processing risks, physical

risks, legal risks, etcrisks, legal risks, etc

The definition excludes reputation risk andThe definition excludes reputation risk andstrategic riskstrategic risk


4/14

44

Regulatory CapitalRegulatory Capital

In Basel II there will be a capital chargeIn Basel II there will be a capital chargefor OperationalRiskfor OperationalRisk

Threealternatives:Threealternatives: Basic Indicator (15% ofannual grossincome)Basic Indicator (15% ofannual grossincome)

Standardized (differentpercentage for eachStandardized (differentpercentage for each

businessline)businessline) Advanced MeasurementApproach (AMA)Advanced MeasurementApproach (AMA)


5/14

55

Categorizationof Business LinesCategorizationof Business Lines

Corporate financeCorporate finance Trading and salesTrading and sales

Retail bankingRetail banking Commercial bankingCommercial banking Paymentand settlementPaymentand settlement

Agency servicesAgency services Asset managementAsset management Retail brokerageRetail brokerage


6/14

66

CategorizationofrisksCategorizationofrisks

Internal fraudInternal fraud External fraudExternal fraud

Employmentpracticesand workplacesafetyEmploymentpracticesand workplacesafety Clients, productsand businesspracticesClients, productsand businesspractices DamagetophysicalassetsDamagetophysicalassets

Business disruptionand system failuresBusiness disruptionand system failures Execution, delivery and process managementExecution, delivery and process management


7/14

77

The Task UnderAMAThe Task UnderAMA

Banksneed to estimatetheir exposuretoBanksneed to estimatetheir exposuretoeach typeofrisk for each businesslineeach typeofrisk for each businessline

combinationcombination

Ideally this willlead to 7Ideally this willlead to 78=8=56 VaR56 VaRmeasuresthat can be combined intoanmeasuresthat can be combined intoan

overall VaR measure (See Chapter 16 foroverall VaR measure (See Chapter 16 forthe way thisis done)the way thisis done)


8/14

88

LossSeverity vs Loss FrequencyLossSeverity vs Loss Frequency

Loss frequency should be estimated from the banksown dataasLoss frequency should be estimated from the banksown dataasfaraspossible. Onepossibility istoassumea Poissonfaraspossible. Onepossibility istoassumea Poissondistributionsothatweneed only estimateanaveragelossdistributionsothatweneed only estimateanaveragelossfrequency. Probability offrequency. Probability ofnn eventsintimeeventsintimeTTisthenisthen

Lossseverity can be based oninternaland external historicalLossseverity can be based oninternaland external historicaldata. (Onepossibility istoassumealognormal distributionsodata. (Onepossibility istoassumealognormal distributionsothatweneed only estimatethe meanand SDoflosses)thatweneed only estimatethe meanand SDoflosses)

Monte Carlosimulation can be used to combinethetwoMonte Carlosimulation can be used to combinethetwodistributions (see Figure 14.2)distributions (see Figure 14.2)

!

)(

ne

n PP


9/14

99

Monte CarloSimulation TrialMonte CarloSimulation Trial

Sample from frequency distributiontoSample from frequency distributiontodeterminethenumberofloss events (=determinethenumberofloss events (=nn))

SampleSamplenn times from thelossseveritytimes from thelossseveritydistributionto determinethelossseveritydistributionto determinethelossseverityfor each loss eventfor each loss event

Sum lossseveritiesto determinetotallossSum lossseveritiesto determinetotalloss


10/14

1010

External Historical LossSeverityExternal Historical LossSeverity

DataData TwopossibilitiesTwopossibilities

datasharingdatasharing

data vendorsdata vendors Data from vendorsis based onpublicly availableData from vendorsis based onpublicly availableinformationand thereforeis biased towardsinformationand thereforeis biased towardslargelosseslargelosses

Data from vendors canthereforeonly be used toData from vendors canthereforeonly be used toestimatetherelativesizeofthe meanlossesandestimatetherelativesizeofthe meanlossesandSDoflosses for differentrisk categoriesSDoflosses for differentrisk categories


11/14

1111

Scaling forSizeScaling forSize

0.23estimatealetShihdata,externalUsing

RevenueBBank

RevenueABankBBankforLossObserved

ABankforLossEstimated

!E

v!

E


12/14

1212

Other TechniquesOther Techniques

ScenarioAnalysisScenarioAnalysis Identifying CausalRelationshipsIdentifying CausalRelationships RCSARCSA KRIKRI

Scorecard approachesScorecard approaches

ThepowerlawThepowerlaw


13/14

1313

InsuranceInsurance

Factorsthataffectthe designofanFactorsthataffectthe designofaninsurance contractinsurance contract

Moral hazardMoral hazard AdverseselectionAdverseselection

Totakeaccountofthese factorsthereareTotakeaccountofthese factorsthereare deductiblesdeductibles

coco--insuranceprovisionsinsuranceprovisions

policy limitspolicy limits


14/14

1414

SarbanesSarbanes--OxleyOxley

CEOand CFOare moreaccountableCEOand CFOare moreaccountable SEC has morepowersSEC has morepowers Auditorsarenotallowed to carry outAuditorsarenotallowed to carry out

significantnonsignificantnon--audittasksaudittasks

Auditcommitteeof board mustbe madeAuditcommitteeof board mustbe madeawareofalternativeaccountingawareofalternativeaccountingtreatmentstreatments

CEOand CFO mustreturn bonusesintheCEOand CFO mustreturn bonusesinthe

event financialstatementsarerestatedevent financialstatementsarerestated

operational risk hullrmfich14

Documents