Operational Risk Modeling in Financial Services

PART TwoChallenges of Operational Risk Measurement

In this part of the book, we will discuss the problem of measuring operational risk in the financial industry, focusing principally on the banking sector.

In the first chapter in this part, we will try to define operational risk – not immediately adopting the usual definitions such as the one used by the Basel accords, but trying to find a rationale to justify this definition. We have experienced a lot of discussions on the boundaries of operational risk, so we believe it is useful to take a closer look at these boundaries, in particular with strategic risk.

In the second chapter, we will discuss the importance of operational risk. Operational risk has gained in significance in the past decade, by an order of magnitude for the amount of losses, by a factor of three in terms of regulatory capital, and by a factor of two for the share of regulatory capital it represents. In this second section, we will also discuss the empirical relation between operational risk and profitability. This analysis will support the further discussion of operational risk appetite.

In the third chapter, we will discuss the need for operational risk measurement. This is of course a regulatory requirement, and although the most apparent trend of the regulation is to go back to a simple and comparable measurement through the SMA, we believe that the requirements will increase when it comes to demonstrating the adequacy of the regulatory capital to the ...