Operational Risk Capital Models (2nd edition)
First published:
ISBN: 9781782724223
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Part III: Use Test, Integrating Capital Results into the Institution’s Day-to-day Risk Management
Part III: Use Test, Integrating Capital Results into the Institution’s Day-to-day Risk Management
Introduction
Challenges of operational risk advanced capital models
Part I: Capture and Determination of the Four Data Elements
Collection of operational loss data: ILD and ED
Scenario analysis framework and BEICFs integration
Part II: General Framework for Operational Risk Capital Modelling
Loss data modelling: ILD and ED
Distributions for modelling operational risk capital
Scenario analysis modelling
Exposure-based approaches
BEICFs modelling and integration into the capital model
Hybrid model construction: Integration of ILD, ED and SA
Derivation of the joint distribution and capitalisation of operational risk
Backtesting, stress testing and sensitivity analysis
Regulatory approval report
Evolving from a plain vanilla to a state-of-the-art model
Part III: Use Test, Integrating Capital Results into the Institution’s Day-to-day Risk Management
Strategic and operational business planning and monitoring
Risk/reward evaluation of mitigation and control effectiveness
Appendix 1: Credibility theory
Appendix 2: Mathematical optimisation methods required for operational risk modelling and other risk mitigation processes
Business risk quantification
After describing in Parts I and II the construction of an operational risk capital model, we now look into the integration of this model’s outputs into the day-to-day risk management of the institution, the so-called use test under the Basel and Solvency regulatory frameworks.
The use test is a critical piece of a capital model when used to communicate the solvency of the institution to external parties. It helps to prove that the results of the capital model are internally trusted for use in daily risk management. In addition, it shows the degree to which the institution has implemented an integrated risk management process to effectively mitigate all risks.
An advanced measurement system of operational risk requires thorough research and data collection for obtaining the required deep understanding of risk exposures, dependencies, weaknesses, potential impacts, and so forth, to adequately model the operational risk profile. This understanding of the risk profile will provide the largest benefits from an advanced measurement capital model when used for risk mitigation, permitting a more effective and efficient rationalisation of the operational risk profile and increasing
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