Measurement of Operational Risk

Measurement of Operational
Risk
Approaches to Measure Operational Risk
• Spectrum of approaches
– Basic indicator - based on a single indicator
– Standardized approach - divides banks’ activities into
a number of standardized industry business lines
– Advanced measurement approach
– Loss distribution approach
• Basic Indicator
– 30% of gross income
Proposed Operational Risk Capital Requirements
Reduced from 20% to 12% of a Bank’s Total Regulatory Capital

Requirement (November, 2001)
Based on a Bank’s choice:
(a) Basic Indicator Approach which levies a single operational

risk charge for the entire bank
or
(b) Standardized Approach which divides a bank’s different

lines of business, each with its own operational risk
charge
or
(c) Advanced Management Approach which uses the bank’s

own internal models of operational risk measurement to
assess a capital requirement
Basel I
• Two minimum standards

– Asset to capital multiple
– Risk based capital ratio
• Scope is limited
– Portfolio effects missing: a well diversified portfolio is
much less likely to suffer massive losses
– Netting is absent
• No market or operational risk

Basel I
• Calculate risk weighted assets for on-balance sheet

items.
• Assets are classified into categories.
• Risk-capital weights are given for each category of

assets.
• Asset value is multiplied by weights.
• Off-balance sheet items are expressed as credit

equivalents.
Minimum Capital Requirement Pillar One
Operational Risk Measurement
• Step1: Input assessment of all significant operational risk
– Audit reports
– Regulatory reports
– Management reports
• Step2: Risk assessment framework

– Risk categories (internal dependencies: people, process,
technology and external dependencies)
– Connectivity and interdependence
– Change, complexity, complacency
– Net likelihood assessment
– Severity assessment
– Combining likelihood and severity into an overall risk
assessment
– Defining cause and effect
– Sample risk assessment report
Operational Risk Measurement
• Step3: Review and validation
• Step4: output
Operational Risk - Basic Indicator Approach
• Capital requirement = α% of gross income
• Gross income = Net interest income

+
Net non-interest income
Note:  supplied by BIS (currently  = 30%)

Example
• Bank’s Gross Income = Rs.395,479,059
• Capital charge for operational risk
• 30% of Gross Income = Rs.118,643,717
or
• 15% of Gross Income = Rs.59,321,858

Basic Indicator Approach
BIS RBI Deficiency /

Bank ($ Million) (.3) (.15) Capital Surplus
State Bank of India 38.9 19.4 1.16 -1574.13
Punjab National Bank 11.5 5.72 0.7 -717.14
ICICI Bank Ltd. 11.3 5.62 2.76 -103.62
Bank of Baroda 2.96 1.48 0.81 -82.71
Canara Bank 3.28 1.64 0.91 -80.21
Corporation Bank 1.1 0.55 0.31 -77.41
Oriental Bank of Commerce 1.42 0.71 0.55 -29.09

HDFC Bank Ltd. 1.79 0.89 0.69 -28.98
Bank of India 2.48 1.24 1.08 -14.81
Syndicate Bank 1.55 0.77 1.15 33.04
UTI Bank 0.9 0.45 0.61 26.22
Union Bank 1.87 0.93 1.12 16.96
Operational Risk - Standardized Approach
• Banks’ activities are divided into standardized business

lines.
• Within each business line:

– specific indicator reflecting size of activity in that area
– Capital chargei = βi x exposure indicatori
• Overall capital charge =

sum of requirements for each business line
Operational Risk - Standardized Approach
Business Line Exposure Indicator Capital

Factor
Corporate Finance Gross Income ß1

Investment trades Gross Income (VaR) ß2
Retail Banking Annual Average Assets ß3
Commercial Banking Annual Average Assets ß4
Fee Based Service Gross Income ß5
Asset Management Funds under Management ß6
Note: Definition of exposure indicator and ßi given by Bank for International Settlements
Advanced Management Approach
• Qualitative standards – organizational requirements to create
an independent operational risk function
• Quantitative standards – collection of operational loss data

and the development of operational risk measurement
models.
– capturing potentially severe tail loss events with a 99.99
percentile confidence interval
– Track internal loss data based on a minimum five-year
observation period
– Use relevant external data
– Use scenario analysis (expert opinion along with external
data to evaluate its exposure to high-severity events)
Qualitative Risk Measure
• Critical assessment method
– Questionnaire format and interviews with bank

managers to identify operational risk events.
Key Risk Indicators approach
• Identifying indicators to measure the scope of business

loss and the risk involved.
• Example: portfolio size, volume of transactions traded,

volume of deals routed through payment and settlement
systems.
• Key risk indicators is more a predictive model than a

cause-and-event approach.
Loss Distribution Approach (LDA)
• Identifying the distribution of historical loss events.

• Quantitative measures such as expected loss and
operational value at risk.
Scenario Generation Approach
• Loss Scenario Modeling.

• Simulation models for loss scenarios based on the
events and loss captured.
Risk Identification Matrix
Capital Requirements for Operational Risk Management
Operational Risk Management Triangle
Daily Business Operations
• Client level
• Advisory role
• Risk mitigation measure
• Execution of measures
Risk Assessment
• Self assessment
• Duration of risk
• Errors in assessment
• Cost due to assessment
• Analysis of risk
Financial Implication
• Loss from operations
• Capital requirement
• Value additions to the bank

Performance Measurement
• Control of operational risk
• Optimization of investment
• Identification of best practices
• Benchmarking

Measurement of Operational Risk

Uploaded by

Copyright:

Available Formats

Measurement of Operational Risk

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Measurement of Operational Risk

Uploaded by

Copyright:

Available Formats

Measurement of Operational

Reduced from 20% to 12% of a Bank’s Total Regulatory Capital

Based on a Bank’s choice:

(a) Basic Indicator Approach which levies a single operational

(b) Standardized Approach which divides a bank’s different

(c) Advanced Management Approach which uses the bank’s

• Two minimum standards

• No market or operational risk

• Calculate risk weighted assets for on-balance sheet

• Assets are classified into categories.

• Risk-capital weights are given for each category of

• Asset value is multiplied by weights.

• Off-balance sheet items are expressed as credit

• Step2: Risk assessment framework

• Step3: Review and validation

• Capital requirement = α% of gross income

• Gross income = Net interest income

Note:  supplied by BIS (currently  = 30%)

• Bank’s Gross Income = Rs.395,479,059

• Capital charge for operational risk

• 30% of Gross Income = Rs.118,643,717

• 15% of Gross Income = Rs.59,321,858

BIS RBI Deficiency /

Oriental Bank of Commerce 1.42 0.71 0.55 -29.09

• Banks’ activities are divided into standardized business

• Within each business line:

• Overall capital charge =

Business Line Exposure Indicator Capital

Corporate Finance Gross Income ß1

• Quantitative standards – collection of operational loss data

• Critical assessment method

– Questionnaire format and interviews with bank

• Identifying indicators to measure the scope of business

• Example: portfolio size, volume of transactions traded,

• Key risk indicators is more a predictive model than a

• Identifying the distribution of historical loss events.

• Loss Scenario Modeling.

• Risk mitigation measure

• Cost due to assessment

• Loss from operations

• Value additions to the bank

• Control of operational risk

• Identification of best practices

You might also like