Operational Risk Capital Models (2nd edition)
First published:
ISBN: 9781782724223
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Business risk quantification
Lutz Baumgarten
Business risk quantification
Introduction
Challenges of operational risk advanced capital models
Part I: Capture and Determination of the Four Data Elements
Collection of operational loss data: ILD and ED
Scenario analysis framework and BEICFs integration
Part II: General Framework for Operational Risk Capital Modelling
Loss data modelling: ILD and ED
Distributions for modelling operational risk capital
Scenario analysis modelling
Exposure-based approaches
BEICFs modelling and integration into the capital model
Hybrid model construction: Integration of ILD, ED and SA
Derivation of the joint distribution and capitalisation of operational risk
Backtesting, stress testing and sensitivity analysis
Regulatory approval report
Evolving from a plain vanilla to a state-of-the-art model
Part III: Use Test, Integrating Capital Results into the Institution’s Day-to-day Risk Management
Strategic and operational business planning and monitoring
Risk/reward evaluation of mitigation and control effectiveness
Appendix 1: Credibility theory
Appendix 2: Mathematical optimisation methods required for operational risk modelling and other risk mitigation processes
Business risk quantification
Typically, business risk is referred to as “the risk of volumes decreasing or margins shrinking with no opportunity to offset the revenue decline with a reduction in costs”. Business risk factors include a competitive environment, the macroeconomic environment, political risks, new product risks, strategic risks, reputational risks, regulatory risks, legal risks, tax risks and IT risks. Business risk quantification completes the universe of risks for capital requirement estimation and financial planning, and can be implemented with the help of a scenario-based approach (SBA), as explained in this appendix.
Historically, the development of formal risk quantification processes and corresponding capital estimations has been driven by the availability of data for quantification and the effectiveness of the risk management actions derived from the risk quantification metrics, rather than the risk potential impact on shareholder value. Market risk quantification started to be widely adopted in the late 1980s, facilitated by RiskMetrics methods. Market risk data is the most plentiful, and risk management can be performed easily by buying and selling securities and derivatives in
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