Forward-looking and incentive-compatible operational risk capital framework

Marco Migueis

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Need to know

Current operational risk regulation and the new standardized approach for operational risk capital set by the Basel Committee are not sufficiently forward-looking.
A forward-looking perspective can be introduced to operational risk capital requirements, while limiting gaming, by adopting an incentive-compatible mechanism.
Such an approach would likely improve upon the risk sensitivity of the AMA and the new standardized approach and be more useful for operational risk management.

Abstract

This paper proposes an alternative framework for setting banks’ operational risk capital, which allows for forward-looking assessments and limits gaming opportunities by relying on an incentive-compatible mechanism. This approach promises to mitigate the vulnerability to gaming of the advanced measurement approach as well as the lack of risk sensitivity of the Basel Committee on Banking Supervision’s new standardized approach for operational risk.

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