Operational Risk Data SRM
Operational Risk Data SRM
Operational Risk
1• Calculate the regulatory capital using the basic indicator approach and the standardized
approach.
2• Explain the Basel Committee’s requirements for the advanced measurement approach
(AMA) and their seven categories of operational risk.
3• Explain how to get a loss distribution from the loss frequency distribution and the loss
severity distribution using Monte Carlo simulations.
4• Describe the common data issues that can introduce inaccuracies and biases in the
estimation of loss frequency and severity distributions.
5• Describe how to use scenario analysis in instances when there is scarce data.
6• Describe how to identify causal relationships and how to use risk and control self
assessment (RCSA) and key risk indicators (KRIs) to measure and manage operational risks.
7• Describe the allocation of operational risk capital and the use of scorecards.
AIM 5-1
Calculate the regulatory capital using the basic indicator approach and the
standardized approach
three options available for the calculation of operational risk regulatory capital
1. Basic Indicator Approach
2. Standardized Approach
3. Advanced Measurement Approach
Basic indicator approach (BIA):
• - An aggregate measure of business activity: fee income, operating costs, or assets.
The capital charge equals a fixed percentage (alpha factor) of the exposure
indicator(EI, currently defined as gross income under BIA and SA):
• - Currently, α has been set at approximately 15%.
• - Advantage: Simple, transparent, and uses readily available data.
- Problems:
• (i) Understate the ORC if the bank reported a weak profitability performance.
• (ii) Does not account for the quality of controls. As a result, this approach is
expected to be mainly used by non-sophisticated banks.
Standardized approach (SA):
• - This divides the bank’s activities into a number of standardized business units. Each business
line is then characterized by an exposure indicator ,taken as gross income for simplicity. The
capital charge is obtained by multiplying each exposure indicator by a fixed percentage (beta
factor) and summing across business lines.
• Advantage: Still simple but better reflects varying risks across business lines.
AIM 5-2
Explain the Basel Committee’s requirements for the advanced measurement
approach (AMA) and their seven categories of operational risk
Structure/steps of LDA:
- Step (1): Organize and group loss data into a “BL/ET matrix” that corresponds to
LDA model. Basel II requires that all internal loss data be clearly mapped into
seven operational risk ET and eight BL, which produces 56 units of measure.
- Step (2): Assign an equal weight on every data point in the matrix, except for split
losses (losses are assigned to more than one business line), old losses, and
external losses and scenario.
- Step (3): Model a loss distribution in each cell of the matrix based on actuarial
approach by separately deriving “distribution for event frequency” and
“distribution for severity” and then combining them using the Monte Carlo
simulation. The loss distributions for various types of operational risk events are
then aggregated through the modeling of their dependence structure to generate
the aggregate loss distribution.
- Step (4): Determine capital requirement at the required confidence level. Then
allocated capital for each business line by combining empirical distributions and
parametric distributions.
BL/ET matrix
AIM 5-4
Describe the common data issues that can introduce inaccuracies and biases
in the estimation of loss frequency and severity distributions