This document discusses operational risk modeling challenges for Basel II. It provides an overview of Basel II, including its three pillars and objectives to ensure safety and soundness while maintaining appropriate capital levels. For operational risk, Basel II allows advanced approaches like the Advanced Measurement Approach (AMA) where banks can develop their own models, subject to regulatory standards. Effective modeling requires capturing tail events using internal and external loss data, scenarios, and incorporating dependence. Many banks are still developing their AMA models to meet requirements. Common challenges include data thresholds distorting loss distributions and external data reporting biases.
This document provides an agenda and overview for a presentation on interest rate risk modeling and management. It discusses supervisory expectations, capabilities of the ALM5 tool, how the tool can be used for risk management versus compliance, key issues in interest rate risk architecture, and concludes with a summary review. The presentation aims to help financial institutions better understand balance sheet management and interest rate risk modeling.
Operational Risk Management Under Basel II & Basel IIIEneni Oduwole
This presentation discusses operational risk under Basel II and III. It provides an overview of the evolution of Basel guidelines and the focus of the Basel II framework on providing capital standards for banks to mitigate financial and operational risks. It defines operational risk and discusses the approaches to estimating capital - basic indicator, standardized, and advanced measurement. The presentation notes some pitfalls of Basel II and the focus of Basel III on increased capital requirements and liquidity standards. It addresses ongoing challenges in operational risk management and potential improvements.
Financial Risk Management Framwork & Basel Ii Icmapjhsiddiqi2003
Javed H Siddiqi discusses risk management and the Basel Accords. The document covers:
1) An overview of risk management, including definitions of risk, the risk management process, and assessing risk tolerance.
2) A summary of the Basel I accord, including how it calculated regulatory capital requirements for credit and market risk.
3) An overview of the Basel II accord, which introduced approaches for calculating capital for operational risk and made capital requirements more risk sensitive.
The document provides an overview of Basel II, including its background, main elements, and implementation process. It discusses:
- The three pillars of Basel II - minimum capital requirements, supervisory review, and market discipline.
- The different approaches for calculating capital requirements for credit, operational, and market risk. This includes standardized and internal ratings-based approaches.
- The importance of the supervisory review process in Pillar 2 for banks to assess their capital adequacy beyond regulatory minimums.
- The role of enhanced disclosure in Pillar 3 to improve market discipline.
It emphasizes that countries should consider their own banking system's readiness before implementing Basel II and that there is no single approach, with
Basel II is an international banking accord that establishes capital requirements for banks. It aims to create an international standard for how much capital banks need to put aside to guard against financial and operational risks. Basel II includes three pillars: minimum capital requirements, supervisory review, and market discipline. It addresses deficiencies in Basel I by incorporating additional risk categories like credit and operational risk. Implementing Basel II poses challenges for Indian banks like increased capital requirements, the need for risk management expertise and technology investments. However, gradual implementation could help Indian banks migrate smoothly to the new framework.
Riskpro Basel III Offering provides comprehensive advisory services to help banks comply with Basel III regulations. This includes 1) assessing any gaps in a bank's risk management frameworks, data, models, and skills, 2) creating a roadmap and timeline for compliance, and 3) providing ongoing support and guidance during implementation. Riskpro takes a customized approach and offers services related to capital management, liquidity risk, credit/market risk modeling, and training to ensure banks meet both regulatory requirements and business objectives under Basel III.
Ratio Analysis of ACI Limited (Bangladesh)Sunanda Sarker
Basel II is an international banking accord that provides recommendations on banking regulations regarding capital adequacy requirements. It aims to ensure banks have enough capital reserves to account for credit risk from borrower defaults. Basel II builds upon Basel I by separating operational risk from credit risk and allowing banks to use internal models to calculate capital requirements. It has three pillars: minimum capital requirements, supervisory review, and market discipline through disclosure requirements.
This document provides an overview of a project proposal to model and measure operational risk in investment banks. It discusses how operational failures at investment banks can be costly and damaging. It reviews the Basel II accord's definition of operational risk and categories of operational risk events. It also outlines three main approaches to measuring operational risk under Basel II - the basic indicator approach, advanced measurement approach, and standardized approach. The proposal aims to identify a unique way to quantify operational risk in investment banks that is acceptable globally.
This document provides an agenda and overview for a presentation on interest rate risk modeling and management. It discusses supervisory expectations, capabilities of the ALM5 tool, how the tool can be used for risk management versus compliance, key issues in interest rate risk architecture, and concludes with a summary review. The presentation aims to help financial institutions better understand balance sheet management and interest rate risk modeling.
Operational Risk Management Under Basel II & Basel IIIEneni Oduwole
This presentation discusses operational risk under Basel II and III. It provides an overview of the evolution of Basel guidelines and the focus of the Basel II framework on providing capital standards for banks to mitigate financial and operational risks. It defines operational risk and discusses the approaches to estimating capital - basic indicator, standardized, and advanced measurement. The presentation notes some pitfalls of Basel II and the focus of Basel III on increased capital requirements and liquidity standards. It addresses ongoing challenges in operational risk management and potential improvements.
Financial Risk Management Framwork & Basel Ii Icmapjhsiddiqi2003
Javed H Siddiqi discusses risk management and the Basel Accords. The document covers:
1) An overview of risk management, including definitions of risk, the risk management process, and assessing risk tolerance.
2) A summary of the Basel I accord, including how it calculated regulatory capital requirements for credit and market risk.
3) An overview of the Basel II accord, which introduced approaches for calculating capital for operational risk and made capital requirements more risk sensitive.
The document provides an overview of Basel II, including its background, main elements, and implementation process. It discusses:
- The three pillars of Basel II - minimum capital requirements, supervisory review, and market discipline.
- The different approaches for calculating capital requirements for credit, operational, and market risk. This includes standardized and internal ratings-based approaches.
- The importance of the supervisory review process in Pillar 2 for banks to assess their capital adequacy beyond regulatory minimums.
- The role of enhanced disclosure in Pillar 3 to improve market discipline.
It emphasizes that countries should consider their own banking system's readiness before implementing Basel II and that there is no single approach, with
Basel II is an international banking accord that establishes capital requirements for banks. It aims to create an international standard for how much capital banks need to put aside to guard against financial and operational risks. Basel II includes three pillars: minimum capital requirements, supervisory review, and market discipline. It addresses deficiencies in Basel I by incorporating additional risk categories like credit and operational risk. Implementing Basel II poses challenges for Indian banks like increased capital requirements, the need for risk management expertise and technology investments. However, gradual implementation could help Indian banks migrate smoothly to the new framework.
Riskpro Basel III Offering provides comprehensive advisory services to help banks comply with Basel III regulations. This includes 1) assessing any gaps in a bank's risk management frameworks, data, models, and skills, 2) creating a roadmap and timeline for compliance, and 3) providing ongoing support and guidance during implementation. Riskpro takes a customized approach and offers services related to capital management, liquidity risk, credit/market risk modeling, and training to ensure banks meet both regulatory requirements and business objectives under Basel III.
Ratio Analysis of ACI Limited (Bangladesh)Sunanda Sarker
Basel II is an international banking accord that provides recommendations on banking regulations regarding capital adequacy requirements. It aims to ensure banks have enough capital reserves to account for credit risk from borrower defaults. Basel II builds upon Basel I by separating operational risk from credit risk and allowing banks to use internal models to calculate capital requirements. It has three pillars: minimum capital requirements, supervisory review, and market discipline through disclosure requirements.
This document provides an overview of a project proposal to model and measure operational risk in investment banks. It discusses how operational failures at investment banks can be costly and damaging. It reviews the Basel II accord's definition of operational risk and categories of operational risk events. It also outlines three main approaches to measuring operational risk under Basel II - the basic indicator approach, advanced measurement approach, and standardized approach. The proposal aims to identify a unique way to quantify operational risk in investment banks that is acceptable globally.
Basel II is an international standard that establishes capital requirements for banks to guard against financial and operational risks. It consists of three pillars: minimum capital requirements to cover credit, market and operational risks; supervisory review to ensure adequate capital to cover all risks; and market discipline through disclosure requirements. While Basel II aims to make capital requirements more risk sensitive, Indian banks face challenges in implementing it due to lack of risk management expertise, need for technology investments, and restructuring of non-performing assets. A gradual implementation process will help ensure a smooth transition to the new framework.
Basel II is an international banking standard that recommends regulations for how much capital banks must hold. It aims to make capital requirements more risk sensitive by aligning them with banks' financial and operational risks. The three pillars of Basel II are: 1) Minimum capital requirements based on credit, market, and operational risk; 2) Supervisory review of risk profiles and capital adequacy; 3) Market discipline through disclosure and transparency. Implementing Basel II poses challenges for Indian banks like additional capital requirements and favoring large banks with stronger risk management.
Basel II is an international banking accord that establishes regulations on how much capital banks need to hold to protect against losses from various risks. It has three pillars - Pillar 1 sets minimum capital requirements for credit, market and operational risk. Pillar 2 deals with supervisory review of a bank's risk management framework. Pillar 3 focuses on market discipline through disclosure requirements. The accord aims to make capital requirements more risk sensitive and improve on the original 1988 Basel Accord.
In this article we give a brief introduction to the meaning of the term operational risk and what it means for the financial institutions of today. We explain the subject as it is defined in Basel II, and show the three different ways of calculating capital requirement for operational risk. In the next article, “Part II: Establishing a Framework for Operational Risk”, we will look at a first step in implementing a framework for operational risk management.
The document discusses operational risk and Basel II regulations. It defines operational risk as losses from internal failures or external events. It outlines the three pillars of Basel II which establish minimum capital requirements, supervisory review, and market discipline. It describes the different approaches for calculating operational risk capital charges, including the Basic Indicator Approach, Standardized Approach, and Advanced Measurement Approach.
The document discusses operational risk and provides guidance on defining, identifying, measuring, monitoring, controlling, and mitigating operational risk according to the Basel Committee on Banking Supervision. It addresses issues with operational risk loss data and outlines principles for developing an appropriate operational risk management environment, process, and framework. The document also examines challenges with using internal and external loss data for quantifying operational risk capital requirements.
The document discusses the evolution of the Basel Accords from 1988 to the present. It highlights that:
1) Basel I, adopted in 1988, aimed to strengthen bank stability and create equal competition. However, it only considered credit risk and encouraged regulatory arbitrage.
2) Basel II, introduced in 2004, aimed to make capital requirements more risk-sensitive by incorporating banks' internal risk management. It included three pillars for minimum capital, supervisory review, and market discipline.
3) While Basel III, finalized in 2010 after the financial crisis, aims to mitigate past damage, the results of its stricter capital standards are still to be seen as countries implement its guidelines.
This summary provides the key points from the document in 3 sentences:
Basel II compliance measures aim to strengthen risk management in banks but many are unprepared for the new regulations taking effect in 2006, with only 5% of large banks implementing components and costs expected to exceed $61 million. Experts recommend splitting compliance teams or breaking down silos to focus on routine processing separately from compliance strategies, and comparing current practices to the three pillars of Basel II to determine readiness. Risk management advocates argue for adopting a proactive approach rather than panic, noting opportunities to leverage existing risk management tools and compliance best practices from Sarbanes-Oxley to facilitate Basel II adoption.
Aon FI Risk Advisory - Simplified Approaches to Op Risk CapitalEvan Sekeris
The Basel Committee is proposing changes to the regulatory framework for operational risk capital requirements in order to restore credibility and comparability after issues were identified during the financial crisis. This includes revising the simpler approaches to increase overall capital levels held by banks by 20-70%, as well as introducing a capital floor of 80-90% of levels required under standard approaches. For European banks, these changes will likely result in significantly increased operational risk capital requirements and force some to recalibrate their internal models. The proposals may have less impact in the US where losses have already been incorporated into capital levels. The committee is reserving the right to make more radical changes to operational risk capital modeling under Pillar 1 if internal models do not prove their value
Basel II is an international standard that aims to strengthen the regulation, supervision and risk management within the banking sector. It improves upon Basel I by making capital requirements more risk sensitive and aligning regulatory capital more closely with underlying bank risks. Basel II consists of three pillars that cover minimum capital requirements, supervisory review, and market discipline. Implementation of Basel II varies across countries and regulators but aims to modernize capital adequacy standards to be more comprehensive and risk sensitive.
Basel II Risk Compliance Solution(Tasso ): Lera technologiesLera Technologies
Lera Technologies has expertise in understanding the geography-specific Basel II implementation
requirements and the associated challenges. We can help your bank gain from the implementation through
our Tasso - Basel II Implementation Framework
Market Practice Series (Credit Losses Modeling)Yahya Kamel
The Central Bank of Egypt “CBE” has adopted IFRS in year 2008. In specific IAS 39 has a discussion about implementing a model that can derive the incurred credit losses for a pool of receivables/ loans, which was quite open for market development & practical initiatives.
From the part of the CBE, it has adopted same approach, which led to some wide different market practices, logic, and interpretations, which sometimes have been questionable on a wide scale basis!
So, I've thought to develop some sort of materials that can serve as a practical guidance for quantifying the credit risk, using different simple models, based on Basel II definitions of the risk components.
The intended users of this material are the credit risk professionals who conduct risk analysis, implement risk management policies, or/and are in charge of quantifying the credit risk for a loan portfolio (corporate & retail).
Also, other professionals or officers complying with IFRS, or CBE GAAP.
The document discusses the Basel II Accords, which establish international standards for banking regulations and capital requirements. Basel II aims to make capital requirements more risk-sensitive by measuring credit, operational, and market risks. It introduces a three pillar framework: Pillar 1 sets minimum capital standards; Pillar 2 establishes supervisory review; and Pillar 3 promotes market discipline through disclosure. Implementation of Basel II varies by country and bank sophistication in risk measurement. The overall goal is a safer, more stable global banking system.
The document summarizes the role and responsibilities of the Chief Risk Officer (CRO) at Credit Suisse. It discusses the CRO's expectations to have independence while being integrated, credibility from experience, and willingness to voice opinions. It outlines Credit Suisse's risk governance structure and the CRO division's organization globally and by region. It also discusses elements of successful risk management at Credit Suisse, including board involvement, balanced risk committees, clear accountability, and institutionalized skepticism. The presentation concludes by emphasizing the priorities of best-in-class risk management and being ahead of regulators.
The document discusses the Capital Adequacy Ratio (CAR) and its evolution over time from Basel I, II, and III accords. CAR is a ratio used by regulators to assess a bank's capital adequacy by comparing its capital to risk-weighted assets. The Basel accords established international standards for CAR and defined components like Tier 1 capital, Tier 2 capital, and risk weighting of assets. Basel III aimed to strengthen banks' ability to absorb shocks by improving capital quality and introducing liquidity ratios and leverage ratios.
This document provides an overview of risk management and Basel II. It discusses key concepts such as types of capital, economic capital, regulatory capital, expected and unexpected loss. It also summarizes the three pillars of Basel II including minimum capital requirements, supervisory review process, and market discipline. Approaches for credit risk, operational risk and market risk management under Basel II are outlined. The document also covers topics like value at risk, credit risk mitigation, and best practices in credit risk management.
Regulations and standards have evolved in response to issues revealed by the 2007 financial crisis. Basel 2 aimed to better capture credit, market, and operational risk, while Basel 2.5 focused on risks from extreme events and Basel 3 aimed to strengthen capital requirements and address systemic risk and liquidity risk. Accounting standards like IFRS 9 and IFRS 13 also evolved to converge with prudential rules regarding areas like impairment models and fair value measurement. The standards have broadened in scope to establish more comprehensive frameworks for risk management across different areas.
This document discusses regulations and standards that govern the banking system. It provides context on factors that drive regulations, including the 2007-2008 financial crisis which revealed shortcomings in risk management. Major standards discussed include Basel II, Basel 2.5, Basel III, IFRS 9, and IFRS 13. Each standard addresses specific objectives like strengthening capital requirements, managing liquidity risk, and increasing transparency. The document also outlines the principles and objectives of the various standards, with a focus on Basel II, Basel 2.5, and how they aim to improve risk measurement and management.
This document discusses the Capital Adequacy Ratio (CAR) and its evolution over time from Basel I to Basel III. It defines CAR as the ratio of a bank's capital to its risk-weighted assets. Basel I established an initial CAR requirement of 8% in 1988. Basel II introduced a more risk-sensitive approach and recognized additional risks. Basel III further strengthened regulations by improving capital quality and introducing liquidity requirements. The overall purpose was to increase stability in the banking system and strengthen a bank's ability to absorb financial and economic shocks.
Basel II is an international standard that establishes capital requirements for banks to guard against financial and operational risks. It consists of three pillars: minimum capital requirements to cover credit, market and operational risks; supervisory review to ensure adequate capital to cover all risks; and market discipline through disclosure requirements. While Basel II aims to make capital requirements more risk sensitive, Indian banks face challenges in implementing it due to lack of risk management expertise, need for technology investments, and restructuring of non-performing assets. A gradual implementation process will help ensure a smooth transition to the new framework.
Basel II is an international banking standard that recommends regulations for how much capital banks must hold. It aims to make capital requirements more risk sensitive by aligning them with banks' financial and operational risks. The three pillars of Basel II are: 1) Minimum capital requirements based on credit, market, and operational risk; 2) Supervisory review of risk profiles and capital adequacy; 3) Market discipline through disclosure and transparency. Implementing Basel II poses challenges for Indian banks like additional capital requirements and favoring large banks with stronger risk management.
Basel II is an international banking accord that establishes regulations on how much capital banks need to hold to protect against losses from various risks. It has three pillars - Pillar 1 sets minimum capital requirements for credit, market and operational risk. Pillar 2 deals with supervisory review of a bank's risk management framework. Pillar 3 focuses on market discipline through disclosure requirements. The accord aims to make capital requirements more risk sensitive and improve on the original 1988 Basel Accord.
In this article we give a brief introduction to the meaning of the term operational risk and what it means for the financial institutions of today. We explain the subject as it is defined in Basel II, and show the three different ways of calculating capital requirement for operational risk. In the next article, “Part II: Establishing a Framework for Operational Risk”, we will look at a first step in implementing a framework for operational risk management.
The document discusses operational risk and Basel II regulations. It defines operational risk as losses from internal failures or external events. It outlines the three pillars of Basel II which establish minimum capital requirements, supervisory review, and market discipline. It describes the different approaches for calculating operational risk capital charges, including the Basic Indicator Approach, Standardized Approach, and Advanced Measurement Approach.
The document discusses operational risk and provides guidance on defining, identifying, measuring, monitoring, controlling, and mitigating operational risk according to the Basel Committee on Banking Supervision. It addresses issues with operational risk loss data and outlines principles for developing an appropriate operational risk management environment, process, and framework. The document also examines challenges with using internal and external loss data for quantifying operational risk capital requirements.
The document discusses the evolution of the Basel Accords from 1988 to the present. It highlights that:
1) Basel I, adopted in 1988, aimed to strengthen bank stability and create equal competition. However, it only considered credit risk and encouraged regulatory arbitrage.
2) Basel II, introduced in 2004, aimed to make capital requirements more risk-sensitive by incorporating banks' internal risk management. It included three pillars for minimum capital, supervisory review, and market discipline.
3) While Basel III, finalized in 2010 after the financial crisis, aims to mitigate past damage, the results of its stricter capital standards are still to be seen as countries implement its guidelines.
This summary provides the key points from the document in 3 sentences:
Basel II compliance measures aim to strengthen risk management in banks but many are unprepared for the new regulations taking effect in 2006, with only 5% of large banks implementing components and costs expected to exceed $61 million. Experts recommend splitting compliance teams or breaking down silos to focus on routine processing separately from compliance strategies, and comparing current practices to the three pillars of Basel II to determine readiness. Risk management advocates argue for adopting a proactive approach rather than panic, noting opportunities to leverage existing risk management tools and compliance best practices from Sarbanes-Oxley to facilitate Basel II adoption.
Aon FI Risk Advisory - Simplified Approaches to Op Risk CapitalEvan Sekeris
The Basel Committee is proposing changes to the regulatory framework for operational risk capital requirements in order to restore credibility and comparability after issues were identified during the financial crisis. This includes revising the simpler approaches to increase overall capital levels held by banks by 20-70%, as well as introducing a capital floor of 80-90% of levels required under standard approaches. For European banks, these changes will likely result in significantly increased operational risk capital requirements and force some to recalibrate their internal models. The proposals may have less impact in the US where losses have already been incorporated into capital levels. The committee is reserving the right to make more radical changes to operational risk capital modeling under Pillar 1 if internal models do not prove their value
Basel II is an international standard that aims to strengthen the regulation, supervision and risk management within the banking sector. It improves upon Basel I by making capital requirements more risk sensitive and aligning regulatory capital more closely with underlying bank risks. Basel II consists of three pillars that cover minimum capital requirements, supervisory review, and market discipline. Implementation of Basel II varies across countries and regulators but aims to modernize capital adequacy standards to be more comprehensive and risk sensitive.
Basel II Risk Compliance Solution(Tasso ): Lera technologiesLera Technologies
Lera Technologies has expertise in understanding the geography-specific Basel II implementation
requirements and the associated challenges. We can help your bank gain from the implementation through
our Tasso - Basel II Implementation Framework
Market Practice Series (Credit Losses Modeling)Yahya Kamel
The Central Bank of Egypt “CBE” has adopted IFRS in year 2008. In specific IAS 39 has a discussion about implementing a model that can derive the incurred credit losses for a pool of receivables/ loans, which was quite open for market development & practical initiatives.
From the part of the CBE, it has adopted same approach, which led to some wide different market practices, logic, and interpretations, which sometimes have been questionable on a wide scale basis!
So, I've thought to develop some sort of materials that can serve as a practical guidance for quantifying the credit risk, using different simple models, based on Basel II definitions of the risk components.
The intended users of this material are the credit risk professionals who conduct risk analysis, implement risk management policies, or/and are in charge of quantifying the credit risk for a loan portfolio (corporate & retail).
Also, other professionals or officers complying with IFRS, or CBE GAAP.
The document discusses the Basel II Accords, which establish international standards for banking regulations and capital requirements. Basel II aims to make capital requirements more risk-sensitive by measuring credit, operational, and market risks. It introduces a three pillar framework: Pillar 1 sets minimum capital standards; Pillar 2 establishes supervisory review; and Pillar 3 promotes market discipline through disclosure. Implementation of Basel II varies by country and bank sophistication in risk measurement. The overall goal is a safer, more stable global banking system.
The document summarizes the role and responsibilities of the Chief Risk Officer (CRO) at Credit Suisse. It discusses the CRO's expectations to have independence while being integrated, credibility from experience, and willingness to voice opinions. It outlines Credit Suisse's risk governance structure and the CRO division's organization globally and by region. It also discusses elements of successful risk management at Credit Suisse, including board involvement, balanced risk committees, clear accountability, and institutionalized skepticism. The presentation concludes by emphasizing the priorities of best-in-class risk management and being ahead of regulators.
The document discusses the Capital Adequacy Ratio (CAR) and its evolution over time from Basel I, II, and III accords. CAR is a ratio used by regulators to assess a bank's capital adequacy by comparing its capital to risk-weighted assets. The Basel accords established international standards for CAR and defined components like Tier 1 capital, Tier 2 capital, and risk weighting of assets. Basel III aimed to strengthen banks' ability to absorb shocks by improving capital quality and introducing liquidity ratios and leverage ratios.
This document provides an overview of risk management and Basel II. It discusses key concepts such as types of capital, economic capital, regulatory capital, expected and unexpected loss. It also summarizes the three pillars of Basel II including minimum capital requirements, supervisory review process, and market discipline. Approaches for credit risk, operational risk and market risk management under Basel II are outlined. The document also covers topics like value at risk, credit risk mitigation, and best practices in credit risk management.
Regulations and standards have evolved in response to issues revealed by the 2007 financial crisis. Basel 2 aimed to better capture credit, market, and operational risk, while Basel 2.5 focused on risks from extreme events and Basel 3 aimed to strengthen capital requirements and address systemic risk and liquidity risk. Accounting standards like IFRS 9 and IFRS 13 also evolved to converge with prudential rules regarding areas like impairment models and fair value measurement. The standards have broadened in scope to establish more comprehensive frameworks for risk management across different areas.
This document discusses regulations and standards that govern the banking system. It provides context on factors that drive regulations, including the 2007-2008 financial crisis which revealed shortcomings in risk management. Major standards discussed include Basel II, Basel 2.5, Basel III, IFRS 9, and IFRS 13. Each standard addresses specific objectives like strengthening capital requirements, managing liquidity risk, and increasing transparency. The document also outlines the principles and objectives of the various standards, with a focus on Basel II, Basel 2.5, and how they aim to improve risk measurement and management.
This document discusses the Capital Adequacy Ratio (CAR) and its evolution over time from Basel I to Basel III. It defines CAR as the ratio of a bank's capital to its risk-weighted assets. Basel I established an initial CAR requirement of 8% in 1988. Basel II introduced a more risk-sensitive approach and recognized additional risks. Basel III further strengthened regulations by improving capital quality and introducing liquidity requirements. The overall purpose was to increase stability in the banking system and strengthen a bank's ability to absorb financial and economic shocks.
1. Basel II Operational Risk
Basel II Operational Risk Modeling
Implementation & Challenges
Emre Balta1 Patrick de Fontnouvelle2
1 O¢ ce of the Comptroller of the Currency
2 Federal Reserve Bank of Boston
February 5, 2009 / Washington, D.C.
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
2. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
The views expressed in this presentation are solely those of the
presenters and do not re‡ect o¢ cial positions of the Comptroller of
the Currency, the Federal Reserve Bank of Boston or the Federal
Reserve System.
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
3. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Outline
Bank Capital and Basel II
Op Risk – De…nition & Basel II requirements
Op Risk – Modeling: Nature of the Problem
Op Risk – Modeling: Range of Practice
Modeling Issues
Other challenges/next steps
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
4. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Bank Capital
Banks hold capital to absorb unforeseen losses on a
going-concern basis
Higher the capital, the lower the chance of insolvency
(analogous to the well-known ruin probability problem in
actuarial literature)
Strong capital levels reduce the potential for bank failures and
promote …nancial stability by reducing chances of systemic
failures
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
5. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Bank Capital (cont’
d)
In its broadest sense, capital represents the excess of a …nancial
institution’ assets over its liabilities:
s
K0 = V0 L0
We think of a bank as choosing K0 s.t., the odds of the fair value
of assets exceeding the fair value of liabilities, the next period,
equals a speci…c probability, say 0.999
Pr(V1 > L1 ) = 0.999
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
6. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Objectives of Basel II
Safety and Soundness
Ensure consistency with fundamental banking principles yet
recognize innovation
Balance
Attempt to incorporate a reasonable trade-o¤ between
enhanced risk-sensitivity and implementation burden
Aggregate Capital Level
Roughly maintain the current amount of capital in the banking
system
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
7. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Structure of Basel II
Pillar I: Minimum Capital Requirements
A series of approaches of increasing complexity
Pillar I capital covers credit risk, market risk, and operational
risk
Pillar II: supervisory review of capital adequacy
Banks should have a process for assessing their overall capital
adequacy in relation to their risk pro…le and a strategy for
maintaining their capital levels
Risks that are not fully captured by the Pillar 1 process (e.g.,
credit concentration risk, liquidity risk, etc.)
Factors that are not taken into account by the Pillar 1 process
(e.g., interest rate risk in the banking book, business and
strategic risk)
Factors external to the bank (e.g., business cycle e¤ects)
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
8. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Structure of Basel II (cont’
d)
Pillar III: market discipline by allowing market participants to
assess key pieces of information on the capital adequacy of
the institution
scope of application,
capital
risk exposures
risk assessment processes
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
9. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Solvency II vs. Basel II
Capital framework for insurers
Main concern is the liability risk that arises from the nature of
insurance business; Basel II is concerned with asset risks.
Traditional insurance risks such as underwriting risk have no
equivalent in banking
However, techniques used to model this type of risk are often
used to model op risk.
These actuarial models are known as the Loss Distribution
Approach (LDA) in op risk modeling
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
10. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Solvency II vs. Basel II (cont’
d)
Di¤erent capital adequacy approach:
Solvency II emphasizes the run-o¤ approach as opposed to the
going-concern approach for Basel II
TailVaR (ES) is the risk measure under Solvency II; VaR under
Basel II
Model risk is explicitly recognized along with other risk
categories (IAA 2002)
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
11. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
De…ning Operational Risk
The risk of loss resulting from inadequate or failed internal
processes, people and systems,or from external events.
7 loss types including: Fraud, Business Practices, Errors,
System Failures, Physical Damage.
Well-known losses: Mado¤/Santander, SocGen, 9/11, . . .
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
12. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Pillar I for Operational Risk
Alternative approaches provided to accommodate di¤erent levels of
bank sophistication:
Advanced
Basic Indicator Standardized
Measurement
Approach Approach (SA)
Approach
n Supervisor – specified n Supervisor – specified n Bank – defined
parameters parameters model/framework
n Bank-wide measure
Bank- n Business line based n Significant flexibility
n Exposure = GI * 15% n Exposure = GI * Beta n Supervisor – defined
n No specific criteria, but n Beta = 12% -18% standards
banks “encouraged”to
encouraged” n Qualifying criteria n Qualifying criteria
comply with 2003 regarding governance,
Sound Practices Paper risk management, and
risk assessment.
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
13. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Why require capital for operational risk?
Operational losses are an important source of risk for banks.
It may be as high as the capital charge for market risk.
The following table provides the distribution of economic
capital used, in 2006, by risk type, as disclosed by some of the
largest global banks
Distribution of Economic Capital (EC) by Risk Type
2006 Economic Capital
Credit Market Operational
Total
Bank Risk Risk Risk
Citigroup 55% 32% 12% 100%
Credit Suisse* 89% 11% 100%
Deutsche Bank 54% 22% 24% 100%
JPMC 59% 26% 15% 100%
Source: 2006 Annual Reports, Balta (2009)
*Credit Suisse did not disclose separate EC for credit and market risks. Instead, it reports
quot;position riskquot; which combines both.
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
14. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Why require capital for operational risk?
2004 LDCE Results
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
15. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
AMA – Regulatory Requirements
Basel II does not specify a speci…c approach or distributional
assumptions.
However, it should meet the following regulatory requirements:
capture potentially severe tail events
appropriately weight each of the 4 “elements”: internal data,
external data, scenarios and BEICFs
consider dependence
quantify at the 99.9th con…dence level over a one year horizon
granularity of the model – commensurate with the risk pro…le
of the bank
minimum …ve years of data
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
16. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
LDA – Nature of the Problem
Let i index the unit of measure, which may be business line, event
type, etc. . .
Given the frequency process Nt (i ) and the severity process X (i ),
the aggregate loss St (i ) for the unit of measure i is a compound
process de…ned as:
N t (i )
St (i ) = ∑ Xn (i )
n =1
Let Gi be the distribution function of the random sum St (i ) and
X be iid positive random variables. Then, the aggregate loss
distribution for the unit of measure i is denoted by
Gi (x ) = P (St (i ) 6 x )
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
17. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
LDA – Nature of the Problem (cont’
d)
The minimum regulatory capital (MRC) for op risk is calculated as
a quantile of the G at the con…dence level α=0.999:
VaRα (i ) = Gi (α) = inf fx j Gi (x ) > αg
Unless dependence is explicitly modeled, the …rm-wide capital
charge for operational risk is
I
VaRα = ∑ VaRα (i )
i =1
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
18. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
LDA – Nature of the Problem (cont’
d)
Loss distributions vary across loss types and lines of businesses.
Calculate MRC for all UOM and aggregate for …rm-wide MRC.
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
19. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Status of Quanti…cation (2007 ROP)
Signi…cant di¤erences remain across institutions in terms of
level of development of the AMA framework, the amount of
progress being made, and the techniques being applied.
Two banks have well-developed models including
documentation and a credible and systematic approach for
weighting the four elements.
Approximately half of the banks have a working model with
further re…nement needed in the model, documentation and/or
weighting the four elements.
The remaining institutions are in earlier stages of development.
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
20. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Operational Risk Models
Literature Review
The existing literature on operational risk focuses, broadly, on two
issues:
1 estimation of operational risk loss processes using either
extreme value theory or parametric loss distributions (e.g.,
Chavez-Demoulin et al., 2006; de Fontnouvelle et al., 2004; de
Fontnouvelle et al., 2005)
2 application of these estimates to the determination of
economic capital, (e.g., Moscadelli, 2004)
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
21. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Data Threshold for Internal Data
Current Practice
Most of the institutions use a data threshold below which they
do not collect detailed event level information
They have di¤erent thresholds for collection, quanti…cation
and enrichment of internal loss data, with $10,000 continuing
to be the most common for quanti…cation; and that
thresholds sometimes vary by line of business
Issues
The data threshold should be low enough to allow for a good
…t for the frequency and severity distributions
How signi…cant are the biases the threshold introduces in
modeling and its impact on capital?
Would …tting a truncated distribution address the bias?
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
22. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
External Data
Two types of data sources: Data consortiums (e.g., ORX) and
vendors (e.g., Fitch, SAS)
Vendor data tends to have reporting bias towards large losses:
Higher the loss, higher the probability the loss is reported.
Reporting bias causes overestimation of capital. De
Fontnouvelle et al. (2003) treat the truncation points as a r.v.
to correct for the bias.
Consortiums have uniform data truncation, but still consists of
heterogeneous group of banks
Is the severity of loss dependent on the size of the bank?
Combination of elements
Is there a statistically defendable way to scale external data?
Cope & Labbi (2008) investigates using quantile regression to
scale severities from a heterogeneous group of banks
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
23. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Model Selection Criteria
Need for a selection criteria for severity distributions that meets
both the theoretical and the practical concerns. Dutta and Perry
(2006) propose the following:
1 Goodness-of-…t - Statistically, how well does the method …t
the data?
2 Realistic - If a method …ts well in a statistical sense, does it
generate an output commensurate with the risk
pro…le/business mix of a bank ?
3 Model stability - Are the characteristics of the …tted data
similar to the loss data and logically consistent?
4 Model simplicity - Is the method easy to apply in practice, and
is it easy to generate random numbers for the purposes of loss
simulation?
5 Model ‡exibility - How well is the method able to reasonably
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
24. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Extreme Value Theory
GPD Estimates of ξ by Exceedances: In the following example,
Dutta & Perry (2006) show the di¢ culty of getting reasonable
capital estimates at any threshold.
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
25. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Outliers - Incorporation of catastrophe risk into the capital
framework
Institutions have introduced various mechanisms to limit the
impact of outliers:
Traditional caps
Constrained optimization
Robust estimation.
Some of these techniques may be cause for concern, to the
extent that they result in an unsupported reduction in capital.
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
26. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Dependence
Within the LDA, it is typically assumed that the X ’ are all
s
independent of each other and are also independent of Nt .
The need for explicit dependence assumptions is most obvious
when one calculates enterprise exposure from unit of measure
exposures.
Co-dependence between risk cells
Frequency dependence
Severity dependence
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
27. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Dependence (cont’
d)
Researchers need to show if/how dependence structures can
be estimated using limited data.
If judgement is necessary, how can this be incorporated in a
rigorous manner?
How much dependence do we really think there is in
operational risk?
Intuition suggests that operational losses are by nature
idiosyncratic.
However, history provides multiple examples of seemingly
unrelated tail events occurring at or near the same time.
Modeling tail co-dependence.
Most banks use Gaussian copulas for the sake of convenience.
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
28. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Model Validation
Validation should include the following components:
evaluation of conceptual soundness, process veri…cation and
benchmarking, outcomes analysis.
Model uncertainty may manifest itself in volatile model output
Validation and the role judgment
Developing credible benchmarks for operational risk exposure
would help to better understand exposure to operational risk
(LDCE 2008)
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
29. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
Other Challenges/ Next Steps
Achieving the right balance between models and management
judment is a challenge.
Choosing unit of measure.
Understanding of and controlling for the cognitive biases is a
hurdle for using scenarios
Allocation of capital to business lines
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
30. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
References
Chavez-Demoulin, V., Embrechts, Pl., Neslehova, J., 2006. Quantitative models for operational risk:
Extremes, dependence and aggregation. Journal of Banking and Finance 30, 2635–2658.
Cope, E. and A. Labbi (2008). Operational Loss Scaling by Exposure Indicators: Evidence from the ORX
Database. Journal of Operational Risk
de Fontnouvelle, Patrick, De Jesus-Rue¤, Virginia, Jordan, John S. and Rosengren, Eric S. (2003). Capital
and Risk: New Evidence on Implications of Large Operational Losses. FRB of Boston Working Paper No.
03-5. Available at SSRN: http://ssrn.com/abstract=648164
de Fontnouvelle, P., Rosengren, E., Jordan, J., (2004). Implications of alternative operational risk modelling
techniques. Working paper, Federal Reserve Bank of Boston.
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
31. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
References (cont’
d)
Dutta, Kabir and Perry, Jason (2006). A Tale of Tails: An Empirical Analysis of Loss Distribution Models
for Estimating Operational Risk Capital. FRB of Boston Working Paper No. 06-13. Available at SSRN:
http://ssrn.com/abstract=918880
El-Gamal, M., Inanoglu, H., Stengel, M., 2006. Multivariate estimation for operational risk with judicious
use of extreme value theory. Working paper, O¢ ce of the Comptroller of the Currency.
Embrechts, Paul, Klüppelberg, C., and Mikosch, T. (1997). Modelling of Extremal Events for Insurance and
Finance. Springer, Heidelberg.
FFIEC (2004). Federal Reserve System, O¢ ce of the Comptroller of the Currency, O¢ ce of Thrift
Supervision, and Federal Deposit Insurance Corporation, Results of the 2004 Loss Data Collection Exercise
for Operational Risk, May 2004. Available at http://www.bos.frb.org/bankinfo/qau/papers/pd051205.pdf
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop
32. Outline
Basel II & Bank Capital
Advanced Measurement Approaches (AMA)
Basel II Operational Risk
AMA – Modeling Issues
Other Challenges/ Next Steps
References
References (cont’
d)
Klugman, Stuart A., Panjer, H. H., and Willmot, G. E. (2004). Loss Models: From Data to Decisions.
Wiley-Interscience, Hoboken, NJ.
Moscadelli, M., 2004. The modelling of operational risk: Experience with the analysis of the data collected
by the basel committee. Technical Report 517, Banca d’Italia.
Balta & de Fontnouvelle OCC/NISS Risk Modeling & Regulation Workshop