Journal of Operational Risk

Marcelo Cruz

Welcome to the second issue of the fifth volume of The Journal of Operational Risk. Summer is finally knocking on our doors and before we all go on our welldeserved vacations, I would like to announce another new addition to our editorial board. We welcome Evan Sekeris from the Federal Reserve Bank of Richmond. Evan has been working in the operational risk industry for many years, validating measurement frameworks, risk governance and policies. I trust that most readers would have met him or at least heard from him in one of the seminars in which he participates every year. We have a challenging road ahead in the next few years and his guidance and experience will be extremely important to us.

In this issue we are putting into practice what we have been promoting, regarding the Journal not being an exclusive forum for quantitative analysts.We present, in this issue, three papers that essentially have no formulas but discuss important issues in today’s market. I hope this encourages other potential authors to submit their views to our Journal.

As commented in previous letters we are trying to incentivize practitioners to write their thoughts on operational risk and the current issues in the area, without being too stringent on the technical side. For this reason we developed the Forum section in which we allow a more free expression of thoughts and more specific industry situations that might be of interest to the community. We are happy that our efforts are bearing fruit and we are publishing three papers in the Forum section in this issue, in addition to one great technical paper.

RESEARCH PAPER

In the technical paper, simply named “Calculation of aggregate loss distributions”, Pavel Shevchenko notices that the estimation of operational risk capital under the loss distribution approach requires the evaluation of aggregate (compound) loss distributions. As closed-form solutions are not usually available for the distributions typically used in operational risk, in many cases numerical evaluation is required. Shevchenko reviews numerical algorithms that can be successfully used for this problem. In particular, Monte Carlo, Panjer recursion and Fourier transformation methods are presented. In addition, several closed-form approximations are reviewed.

FORUM PAPERS

In the first paper in the Forum section, “The credit crisis and operational risk – implications for practitioners and regulators”, Andreas A. Jobst highlights the increased importance of operational risk amid greater systemic risk concerns and reviews the current state of operational risk management. He provides some suggestions on the future development of operational risk management – both from an organizational and industry perspective – considering the aftermath of the credit crisis of 2008. In the second paper of the Forum section, “A practical application of extreme value theory to operational risk in banks”, Hela Dahen, Georges Dionne and Daniel Zajdenweber use data from a very large US bank to show that this bank could suffer, on average, more than four major losses a year. This bank had seven losses exceeding hundreds of millions of dollars over its 52 documented losses of more than $1 million during the 1994–2004 period. The tail of the loss distribution shows that this bank can fear extreme operational losses ranging from $1 billion (1%) to $11 billion (0.1%). Translating this analysis for a hedging perspective (insurance), the corresponding annual insurance premiums are estimated to range from $350 million to close to $1 billion to protect this bank against these losses. These are staggering numbers, which should attract the attention of any senior executive in financial institutions. In the third paper in the Forum section, “The measurement of capital for operational risk in Taiwanese commercial banks”, Wo-Chiang Lee and Chiang-Jye Fang continue our series on “the impact of operational risk throughout the world”. We have covered the operational risk impact in the Indian market and now it is the turn of Taiwan. It is hugely interesting to realize the impact that our industry has around the globe.