Part III: Use Test, Integrating Capital Results into the Institution’s Day-to-day Risk Management

Rafael Cavestany

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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