operational risk hullrmfich14
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8/7/2019 Operational Risk HullRMFICh14
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Operational RiskOperational Risk
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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
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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
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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)
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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
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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
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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)
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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)
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n PP
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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
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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
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Scaling forSizeScaling forSize
0.23estimatealetShihdata,externalUsing
RevenueBBank
RevenueABankBBankforLossObserved
ABankforLossEstimated
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v!
E
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Other TechniquesOther Techniques
ScenarioAnalysisScenarioAnalysis Identifying CausalRelationshipsIdentifying CausalRelationships RCSARCSA KRIKRI
Scorecard approachesScorecard approaches
ThepowerlawThepowerlaw
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InsuranceInsurance
Factorsthataffectthe designofanFactorsthataffectthe designofaninsurance contractinsurance contract
Moral hazardMoral hazard AdverseselectionAdverseselection
Totakeaccountofthese factorsthereareTotakeaccountofthese factorsthereare deductiblesdeductibles
coco--insuranceprovisionsinsuranceprovisions
policy limitspolicy limits
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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
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