Operational Risk Management, 2nd Edition

CHAPTER 12Capital Modeling

In this chapter, we explore the various methods for the calculation of operational risk capital and the challenges faced in adopting the Advanced Measurement Approach. New replacement methods are also considered, as these are scheduled for adoption in coming years. Different capital modeling methods are discussed and compared, and the use and importance of correlation and insurance offsets are considered. Finally, the disclosure requirements are introduced.

While banks are required to hold capital if they are subject to Basel II requirements, fintechs do not have this requirement. Fintechs rely on sponsor banks for the provision of much of their banking services, and those sponsor banks are subject to capital requirements in accordance with their national regulators.

OPERATIONAL RISK CAPITAL

Firms that are required to, or that choose to, calculate operational risk capital can select from several methods.

Basel II originally provided three main approaches to calculating operational risk capital: the Basic Indicator Approach, the Standardized Approach, and the Advanced Measurement Approach (AMA) (see Figure 12.1). These three methods will be considered first as they are still in place at the time of writing and were affirmed in 2019.¹ However, future simplification of the calculation is scheduled for implementation soon and those new approaches are considered later in this chapter.

If an AMA is being used, then the calculation will draw on the underlying ...