Measuring and Calculating Economic Operational Risk Capital
Anthony Peccia
Introduction
Background on Economic Capital
Volatility and Capital: Measures of Risk
Conceptual Framework for Economic Capital Models and Required Inputs
Recovery Risk and Economic Capital
The Significance of Economic Capital to Financial Institutions
Economic Capital for Retail Credit Card Portfolios
Economic Capital for Counterparty Credit Risk
Economic Capital for Securitisations
Economic Capital for Market Risk
Measuring and Calculating Economic Operational Risk Capital
A Fundamental Look at Economic Capital and Risk-Based Profitability Measures
A Risk-Factor Model Foundation for Ratings-Based Bank Capital Rules
Allocating Portfolio Economic Capital to Sub-Portfolios
Spectral Capital Allocation
Evaluating Design Choices in Economic Capital Modelling: A Loss Function Approach
This chapter illustrates how an advanced measurement approach (the AMA in BIS terminology) can be constructed that, based on the loss distribution approach (LDA), integrates internal losses, external losses and credible scenario analysis, and incorporates directly into the measurement process the state of the business and controls environments as determined through risk and control self-assessments (RCSAs), key risk indicators (KRIs) and audit assessments. Through this approach, there is no need for ad hoc and most often arbitrary qualitative adjustments. This approach, called the operational risk ratings approach, directly measures the risks identified in the RCSA, which then provides management with the insight into which controls to improve in order to achieve or maintain the desired level of operational risk.
Economic operational risk capital: what for?
The New Capital Accord (see BIS, 2004), commonly referred to as Basel II, has spawned a lot of interest in operational risk measurement and management. This interest has in turn spawned a variety of operational risk initiatives, ranging from qualitative self-assessments and various forms of operational risk data collection to
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