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    Hull RMFICh 14

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    Ch 14

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    Hull RMFICh 14

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    jlosam
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    Ch 14

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    HullRMFICh14

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    Ch 14

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    17 views14 pages

    Hull RMFICh 14

    Uploaded by

    jlosam
    Ch 14

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    of 14

    Operational Risk

    Chapter 14

    Risk Management and Financial Institutions, Chapter 14, Copyright John C. Hull 2006

    14.1

    Definition of Operational Risk


    Operational risk is the risk of loss
    resulting from inadequate or failed internal
    processes, people, and systems, or from
    external events
    Basel Committee Jan 2001

    Risk Management and Financial Institutions, Chapter 14, Copyright John C. Hull 2006

    14.2

    What It Includes

    The definition includes people risks,


    technology and processing risks, physical
    risks, legal risks, etc
    The definition excludes reputation risk and
    strategic risk

    Risk Management and Financial Institutions, Chapter 14, Copyright John C. Hull 2006

    14.3

    Regulatory Capital (page 324)

    In Basel II there will be a capital charge for


    Operational Risk
    Three alternatives:

    Basic Indicator (15% of annual gross income)


    Standardized (different percentage for each
    business line)
    Advanced Measurement Approach (AMA)

    Risk Management and Financial Institutions, Chapter 14, Copyright John C. Hull 2006

    14.4

    Categorization of Business Lines

    Corporate finance
    Trading and sales
    Retail banking
    Commercial banking
    Payment and settlement
    Agency services
    Asset management
    Retail brokerage

    Risk Management and Financial Institutions, Chapter 14, Copyright John C. Hull 2006

    14.5

    Categorization of risks

    Internal fraud
    External fraud
    Employment practices and workplace safety
    Clients, products and business practices
    Damage to physical assets
    Business disruption and system failures
    Execution, delivery and process management

    Risk Management and Financial Institutions, Chapter 14, Copyright John C. Hull 2006

    14.6

    The Task Under AMA

    Banks need to estimate their exposure to


    each type of risk for each business line
    combination
    Ideally this will lead to 78=56 VaR
    measures that can be combined into an
    overall VaR measure (See Chapter 16 for
    the way this is done)

    Risk Management and Financial Institutions, Chapter 14, Copyright John C. Hull 2006

    14.7

    Loss Severity vs Loss Frequency (page 327)

    Loss frequency should be estimated from the banks own data as


    far as possible. One possibility is to assume a Poisson
    distribution so that we need only estimate an average loss
    frequency. Probability of n events in time T is then
    e

    (T ) n
    n!

    Loss severity can be based on internal and external historical


    data. (One possibility is to assume a lognormal distribution so
    that we need only estimate the mean and SD of losses)
    Monte Carlo simulation can be used to combine the two
    distributions (see Figure 14.2)

    Risk Management and Financial Institutions, Chapter 14, Copyright John C. Hull 2006

    14.8

    Monte Carlo Simulation Trial


    (page 328)

    Sample from frequency distribution to


    determine the number of loss events (=n)
    Sample n times from the loss severity
    distribution to determine the loss severity
    for each loss event
    Sum loss severities to determine total loss

    Risk Management and Financial Institutions, Chapter 14, Copyright John C. Hull 2006

    14.9

    External Historical Loss Severity Data

    Two possibilities

    data sharing
    data vendors

    Data from vendors is based on publicly available


    information and therefore is biased towards
    large losses
    Data from vendors can therefore only be used to
    estimate the relative size of the mean losses and
    SD of losses for different risk categories

    Risk Management and Financial Institutions, Chapter 14, Copyright John C. Hull 2006

    14.10

    Scaling for Size (page 330)


    Estimated Loss for Bank A
    Bank A Revenue
    Observed Loss for Bank B

    Bank B Revenue

    Using external data, Shih et al estimate 0.23

    Risk Management and Financial Institutions, Chapter 14, Copyright John C. Hull 2006

    14.11

    Other Techniques

    Scenario Analysis (page 331)


    Identifying Causal Relationships (page 332)
    RCSA (page 333)
    KRI (page 333)
    Scorecard approaches (page 334)
    The power law (page 335)

    Risk Management and Financial Institutions, Chapter 14, Copyright John C. Hull 2006

    14.12

    Insurance (page 335-7)

    Factors that affect the design of an insurance


    contract

    Moral hazard
    Adverse selection

    To take account of these factors there are

    deductibles
    co-insurance provisions
    policy limits

    Risk Management and Financial Institutions, Chapter 14, Copyright John C. Hull 2006

    14.13

    Sarbanes-Oxley (page 337)

    CEO and CFO are more accountable


    SEC has more powers
    Auditors are not allowed to carry out
    significant non-audit tasks
    Audit committee of board must be made
    aware of alternative accounting treatments
    CEO and CFO must return bonuses in the
    event financial statements are restated

    Risk Management and Financial Institutions, Chapter 14, Copyright John C. Hull 2006

    14.14

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