Measuring and Managing Operational Risk in the Financial Sector: An Integrated Framework

33 Pages Posted: 7 May 2005  

Ariane Chapelle

University College London - Department of Computer Science

Yves Crama

University of Liege - HEC Management School

Georges Hubner

HEC Management School - University of Liège; Maastricht University - Department of Finance; Gambit Financial Solutions

Jean-Philippe Peters

Deloitte Luxembourg; University of Liege - Economics, Business Administration and Social Sciences

Date Written: February 27, 2005

Abstract

This paper proposes a methodology to analyze the implications of the Advanced Measurement Approach (AMA) put forward by the Basel II Accord for the assessment of operational risk. We develop an integrated procedure for the construction of the distribution of aggregate losses, using internal and external data. It is illustrated on a 2x2 matrix of two selected business lines and two event types, drawn from a database of 3000 losses obtained from a large European banking institution. For each cell, the method calibrates three truncated distributions functions for the body of internal data, the tail of internal data, and external data. When the dependence structure between aggregate losses and the non-linear adjustment of external data are explicitly taken into account, the regulatory capital computed with the AMA method is substantially lower than with less sophisticated approaches, although the effect is not uniform. We then estimate the effects of operational risk management actions on bank profitability, through a measure of RAROC adapted to operational risk. The results suggest that substantial savings can be achieved through active management techniques, although the effect of a reduction of the frequency or severity of operational losses depends on the calibration of the aggregate loss distributions.

Keywords: Basel 2, operational risk, extreme value theory, external data, RAROC

JEL Classification: G20, G21, G28

Suggested Citation

Chapelle, Ariane and Crama, Yves and Hubner, Georges and Peters, Jean-Philippe, Measuring and Managing Operational Risk in the Financial Sector: An Integrated Framework (February 27, 2005). Available at SSRN: https://ssrn.com/abstract=675186 or http://dx.doi.org/10.2139/ssrn.675186

Ariane Chapelle

University College London - Department of Computer Science ( email )

Gower Street
London, WC1E 6BT
United Kingdom
+44(0)7833453854 (Phone)

Yves Crama

University of Liege - HEC Management School ( email )

Boulevard du Rectorat 7 (B31)
LIEGE, Liege 4000
Belgium

Georges Hubner (Contact Author)

HEC Management School - University of Liège ( email )

Rue Louvrex 14, Bldg. N1
Liege, 4000
Belgium
+32 42327428 (Phone)

Maastricht University - Department of Finance ( email )

Maastricht, 6200 MD
Netherlands

Gambit Financial Solutions ( email )

Rue Forgeur 17
Liège, 4000
Belgium

Jean-Philippe Peters

Deloitte Luxembourg ( email )

Rue de Neudorf, 566
Luxembourg, Grand-Duchy of Luxembourg 2220
Luxembourg
+352 451 452 276 (Phone)
+352 451 452 746 (Fax)

HOME PAGE: http://www.deloitte.lu

University of Liege - Economics, Business Administration and Social Sciences

Bld du Rectorat 7 Bat. B31
Liege B-4000
Belgium

HOME PAGE: http://www.egss.ulg.ac.be

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