A Loss Distribution for Operational Risk Derived from Pooled Bank Losses

Capco Institute Journal of Financial Transformation, April 2009

Cass Business School Research

19 Pages Posted: 17 Jul 2010

See all articles by ManMohan S. Sodhi

ManMohan S. Sodhi

City University London - Sir John Cass Business School

Wayne Holland

City University London - Sir John Cass Business School

Date Written: February 11, 2009

Abstract

The Basel II accord encourages banks to develop their own Advanced Measurement Approaches (AMA). However, the paucity of loss data implies that an individual bank cannot obtain a probability distribution with any reliability. We propose a model, targeting the regulator initially, by obtaining a probability distribution for loss magnitude using pooled annual risk losses from the banks under the regulator’s oversight. We start with summarized loss data from 63 European banks and adjust the probability distribution obtained for losses that go unreported by falling below the threshold level. Using our model, the regulator has a tool for understanding the extent of annual operational losses across all the banks under its supervision. The regulator can use the model on an ongoing basis to make comparisons in year-on-year changes to the operational risk profile of the regulated banking sector.

Keywords: Basel II, AMA, loss distribution model, empirical data

Suggested Citation

Sodhi, ManMohan S. and Holland, Wayne, A Loss Distribution for Operational Risk Derived from Pooled Bank Losses (February 11, 2009). Capco Institute Journal of Financial Transformation, April 2009, Cass Business School Research, Available at SSRN: https://ssrn.com/abstract=1640816 or http://dx.doi.org/10.2139/ssrn.1640816

ManMohan S. Sodhi (Contact Author)

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Wayne Holland

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

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