On Operational Risk Stress Testing

Yakov Lantsman, Sabeth Siddique and Yan Shi

This chapter will introduce operational risk and its evolution, as well as common industry practices in operational risk management. It will start by providing a brief background of operational risk and stress testing, followed by a systematic overview of the structures of supervisory and bank idiosyncratic scenarios. Common and useful methodologies in the construction of bank idiosyncratic scenarios will then be articulated. Related post-operational risk calculation work, such as the operational risk model capital buffer, reporting and effective challenge, will be addressed in the final section.

BACKGROUND TO OPERATIONAL RISK STRESS TESTING

History of stress testing

The Federal Reserve expects big, complex bank holding companies (BHCs) to hold sufficient capital to continue lending to support real economic activity, even under adverse economic conditions. Stress testing is one tool that helps banks’ supervisors measure whether a BHC has sufficient capital to support its operations throughout periods of stress. The Federal Reserve previously emphasised the use of stress tests as a means of assessing capital sufficiency under stress during the 2009 Supervisory Capital Assessment