Rethinking Operational Risk Capital Requirements

Abstract

Operational risk capital requirements represent a relative backwater of the Basel capital framework for banks. We examine both the existing Basel II framework and the latest Basel Committee proposals for reform and conclude that neither are effective in creating appropriate incentives and loss absorbency to minimize negative externalities from operational risk events. We evaluate an alternative approach that would appear to be much more effective in achieving the regulatory objectives. We do not offer a view on the amount of capital required, focusing instead on the methodology and structure of the capital requirement.

Analysis of Impacts of Operational Risk Management Practices on Banks’ Financial Performance: Study of Selected Commercial Banks in Nigeria

“…Operational risk is not a new risk; it is simply a tagging of some old risks by regulators to improve the visibility of such risks and drive the culture of self-regulation of banking operations (Hemrit & Arab, 2013;Power, 2003). The notion of operational risk became prominent after the collapse of Barings Bank in 1995 and the 1998 Long-Term Capital Management (LTCM) crisis which investigation credited to failure of operational risk management (Peter, Gordon & Yueran 2018;Siminyu, Clive & Musiega, 2017;Hussain & Shafi, 2014). Prior to this period, operational risk was neglected and viewed as a mere residual risk, that is, part of other risks type that falls outside the purview of market risks and credit risks (Siminyu;Clive & Musiega, 2017;Power, 2003).…”

A fuzzy credibility model to estimate the Operational Value at Risk using internal and external data of risk events

“…However, their role in the recent world financial crisis has been picked up by some scholars [10]. All these models have to consider the following key elements, which are subject to management decisions, related to OpR: causes, events, controls and impact in the estimation of OpVaR; in order to mitigate or remove this type of risk to some extent from an organisation by using, for example, management matrices [11]. Over time, this research trend has established new approaches for the estimation of the OpVaR in financial institutions and in using risk management policies that consider the conditions of the international financial markets [12].…”

Let’s Talk: What FinReg Can Learn from New Governance (and Vice Versa)

“…(Basel Committee on Banking Supervision, 2002, 7-8) For a variety of reasons, however, this self-regulatory approach has been ill-suited to operational risk, as exemplified by a variety of high-profile operational losses in the United States and abroad, including the largest rogue trading loss in history-over $7 billion by Jerome Kerviel of the French Bank, Société Générale (Krawiec 2009;Sands, Liao, and Ma 2018). Systematic reviews also indicate great variability in the manner by which different institutions account for operational risk and a lack of comparability across institutions, making oversight difficult (Sands, Liao, and Ma 2018). In the case of rogue traders, in particular, oversight efforts have been thwarted by a falsifying of the data and records used to perform oversight functions (Krawiec 2009).…”