Sunday 2 August 2009

Operational Risk

The Basel Committee has just published two new papers on operational risk which cover the results from the “2008 Loss Data Collection Exercise”. The 2008 Loss Data Collection Exercise (LDCE) is the first international LDCE to collect information on all four data elements that are used in the Advanced Measurement Approach (AMA) for operational risk in the Basel II Framework - internal loss data, external loss data, scenario analysis and business environment and internal control factors (BEICFs). The 2008 LDCE was conducted for the Basel Committee on Banking Supervision by the Operational Risk Subgroup of the Standards Implementation Group.

The results are covered in two papers. The first, “Results from the 2008 Loss Data Collection Exercise for operational risk”, focuses on internal loss data and scenario analysis as well as on operational risk capital. The second paper, “Observed range of practice in key elements of Advanced Measurement Approaches (AMA)”, covers external loss data and BEICFs as well as the observed range of practice in banks employing the AMA for operational risk.

The results provide a unique opportunity to assess operational risk data and practices across regions, thus furthering the goal of promoting consistency in implementation of the Basel II Accord. The findings also present an opportunity for banking institutions to compare their operational risk management frameworks with those of other institutions and to identify potential areas for improvement.

Here are some of the main findings of the first paper:

  • Overall, banks have made considerable progress in the collection and use of internal loss data since the previous international LDCE, conducted in 2002.
  • The frequency of internal losses of €20,000 or more varies significantly across regions when the data are scaled by various exposure indicators.
  • Despite the regional variation in loss frequency noted above, there is some consistency in the severity distribution of operational losses across regions.
  • Most banks' scenario data extends the tail of the loss distribution beyond the point at which they have experienced internal losses. At many banks, the number of large scenarios greater than €10 million is approximately 20 times larger than the number of internal losses that are greater than this amount.
  • Although the number of large scenarios significantly exceeds the number of large internal losses, the frequency of large losses implied by scenarios and internal data are broadly consistent among AMA banks.
  • AMA banks have a higher frequency of internal losses greater than €100,000 than non-AMA banks, even when the data are scaled by exposure indicators. Some of this difference may be explained by the fact that AMA banks generally are larger, more complex banks with more mature processes for collecting loss data.
  • Operational risk capital for non-AMA banks is higher than for AMA banks, regardless of the exposure indicator used for scaling. For the typical AMA bank, the ratio of operational risk capital to gross income (10.8%) is significantly below the alpha for the Basic Indicator Approach (BIA) (15%) and also below the range of betas for the Standardised Approach (TSA) (12% - 18%). Also, the amount of capital relative to the frequency of large losses is generally higher at non-AMA banks than at AMA banks.

The Observed range of practice (ROP) paper updates a 2006 report of the same name. In framing the discussion of observed practice in the measurement and management of operational risk, the update:

  • Identifies both emerging effective practices as well as practices that are inconsistent with supervisory expectations;
  • Highlights supervisory issues encountered in the supervisory reviews of operational risk, whether related to governance, data or modelling; and
  • Provides a resource for both banks and national supervisors to use in their respective implementation processes, and ongoing development and monitoring of AMA frameworks.

The Basel II Framework envisions that, over time, the operational risk discipline will mature and converge towards a narrower band of effective risk management and risk measurement practices. Understanding the current range of observed operational risk management and measurement practices, both within and across geographic regions, contributes significantly to the efforts to establish consistent supervisory expectations. Through the analysis of existing practices, the Basel Committee is better able to promote the maturation of operational risk practices and support supervisors in developing more consistent regulatory expectations. The ROP paper therefore provides supervisors with an opportunity to engage individual banks in discussions of their operational risk management and measurement practices relative to their peers in domestic and international markets.

The ROP paper does not purport to define best practices. However, in the course of cataloguing and updating the range of observed practice, it is reasonable to expect the Basel Committee to begin identifying practices that might fall outside the range of what supervisors consider acceptable and to highlight effective and sound operational risk practices.
The observations in the ROP paper do not constitute new rules or revisions to the Basel II Framework. Neither does the content reduce or supersede the discretion of national supervisors to act in a manner that is consistent with their particular regulatory approaches. As a result, actions taken by Basel Committee members in response to the observations in this report may vary due to cross-jurisdictional differences in implementation legislation and supervisory approaches. Further, the status of banks accredited to use an AMA framework will not be affected by the observations and conclusions of this paper.

To download the papers directly from the BIS;
Observed Range of Practice in Key Elements of AMA -
http://www.bis.org/publ/bcbs160b.pdf
Results from the 2008 Loss Data Collection Exercise for operational risk -
http://www.bis.org/publ/bcbs160a.pdf

 
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