Operational Risk Modelling and Management

406 Pages·2010·3.444 MB·English

by  Claudio Franzetti

Operational Risk Modelling
and Management
K11986_FM.indd 1 9/1/10 12:40:04 PM
CHAPMAN & HALL/CRC FINANCE SERIES
CHAPMAN & HALL/CRC FINANCE SERIES
Series Editor
Michael K. Ong
Stuart School of Business
Illinois Institute of Technology
Chicago, Illinois, U. S. A.
Operational Risk Modelling
Aims and Scopes
As the vast field of finance continues to rapidly expand, it becomes increasingly important to present the
latest research and applications to academics, practitioners, and students in the field. and Management
An active and timely forum for both traditional and modern developments in the financial sector, this
finance series aims to promote the whole spectrum of traditional and classic disciplines in banking and
money, general finance and investments (economics, econometrics, corporate finance and valuation,
treasury management, and asset and liability management), mergers and acquisitions, insurance, tax
and accounting, and compliance and regulatory issues. The series also captures new and modern
developments in risk management (market risk, credit risk, operational risk, capital attribution, and
liquidity risk), behavioral finance, trading and financial markets innovations, financial engineering,
alternative investments and the hedge funds industry, and financial crisis management.
The series will consider a broad range of textbooks, reference works, and handbooks that appeal to
academics, practitioners, and students. The inclusion of numerical code and concrete real-world case
studies is highly encouraged.
Published Titles
Decision Options®: The Art and Science of Making Decisions, Gill Eapen
Claudio Franzetti
Emerging Markets: Performance, Analysis, and Innovation, Greg N. Gregoriou
Introduction to Financial Models for Management and Planning, James R. Morris SERV
and John P. Daley
Zurich, Switzerland
Pension Fund Risk Management: Financial and Actuarial Modeling, Marco Micocci,
Greg N. Gregoriou, and Giovanni Batista Masala
Stock Market Volatility, Greg N. Gregoriou
Portfolio Optimization, Michael J. Best
Operational Risk Modelling and Management, Claudio Franzetti
Proposals for the series should be submitted to the series editor above or directly to:
CRC Press, Taylor & Francis Group
4th, Floor, Albert House
1-4 Singer Street
London EC2A 4BQ
UK
K11986_FM.indd 2 9/1/10 12:40:04 PM
CHAPMAN & HALL/CRC FINANCE SERIES
CHAPMAN & HALL/CRC FINANCE SERIES
Series Editor
Michael K. Ong
Stuart School of Business
Illinois Institute of Technology
Chicago, Illinois, U. S. A.
Operational Risk Modelling
Aims and Scopes
As the vast field of finance continues to rapidly expand, it becomes increasingly important to present the
latest research and applications to academics, practitioners, and students in the field. and Management
An active and timely forum for both traditional and modern developments in the financial sector, this
finance series aims to promote the whole spectrum of traditional and classic disciplines in banking and
money, general finance and investments (economics, econometrics, corporate finance and valuation,
treasury management, and asset and liability management), mergers and acquisitions, insurance, tax
and accounting, and compliance and regulatory issues. The series also captures new and modern
developments in risk management (market risk, credit risk, operational risk, capital attribution, and
liquidity risk), behavioral finance, trading and financial markets innovations, financial engineering,
alternative investments and the hedge funds industry, and financial crisis management.
The series will consider a broad range of textbooks, reference works, and handbooks that appeal to
academics, practitioners, and students. The inclusion of numerical code and concrete real-world case
studies is highly encouraged.
Published Titles
Decision Options®: The Art and Science of Making Decisions, Gill Eapen
Claudio Franzetti
Emerging Markets: Performance, Analysis, and Innovation, Greg N. Gregoriou
Introduction to Financial Models for Management and Planning, James R. Morris SERV
and John P. Daley
Zurich, Switzerland
Pension Fund Risk Management: Financial and Actuarial Modeling, Marco Micocci,
Greg N. Gregoriou, and Giovanni Batista Masala
Stock Market Volatility, Greg N. Gregoriou
Portfolio Optimization, Michael J. Best
Operational Risk Modelling and Management, Claudio Franzetti
Proposals for the series should be submitted to the series editor above or directly to:
CRC Press, Taylor & Francis Group
4th, Floor, Albert House
1-4 Singer Street
London EC2A 4BQ
UK
K11986_FM.indd 3 9/1/10 12:40:04 PM
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To Rita, Lorenzo, Bibiana, and Francesco

Frustra fit per plura quod potest fieri per pauciora.
(It is vain to do with more what can be done with less.)
William Ockham (1285-1349)
Far better an approximate answer to the right question,
than the exact answer to the wrong question, which can
always be made precise.
John W. Tukey
We move forward, ignoring the risks we create. From
time to time an accident shakes us up from our
numbness, and we glance into the precipice.
Ivar Ekeland

Contents
List of Figures xv
List of Tables xix
Preface xxi
About the Author xxiii
1 Introduction to Operational Risk 1
1.1 Why Regulate Banks? . . . . . . . . . . . . . . . . . . . . . . 1
1.2 Additional Supervision . . . . . . . . . . . . . . . . . . . . . 4
1.3 The Basel Regulatory Effort . . . . . . . . . . . . . . . . . . 10
1.4 Risk and Capital . . . . . . . . . . . . . . . . . . . . . . . . . 13
1.4.1 How Do We Define Risk? . . . . . . . . . . . . . . . . 13
1.4.2 What Is Risk Management? . . . . . . . . . . . . . . . 16
1.4.3 Capital . . . . . . . . . . . . . . . . . . . . . . . . . . 17
1.4.4 Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . 22
1.4.5 Ruin Theory . . . . . . . . . . . . . . . . . . . . . . . 24
1.4.6 Risk and Aversion . . . . . . . . . . . . . . . . . . . . 26
1.5 What Is Operational Risk? . . . . . . . . . . . . . . . . . . . 28
1.6 Economic Capital for Operational Risk . . . . . . . . . . . . 34
1.7 Operational Risk under Basel 2 . . . . . . . . . . . . . . . . 36
1.7.1 Basic Indicator Approach . . . . . . . . . . . . . . . . 36
1.7.2 Standardised Approach . . . . . . . . . . . . . . . . . 37
1.7.3 Advanced Measurement Approach . . . . . . . . . . . 39
1.8 Role of Insurance . . . . . . . . . . . . . . . . . . . . . . . . 40
1.9 Regulation after the Crisis . . . . . . . . . . . . . . . . . . . 44
2 The Problem Context 49
2.1 General Remarks . . . . . . . . . . . . . . . . . . . . . . . . 49
2.2 The Data Problem . . . . . . . . . . . . . . . . . . . . . . . 50
2.2.1 Scaling . . . . . . . . . . . . . . . . . . . . . . . . . . 51
2.2.2 Mixing . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
2.2.3 Paucity . . . . . . . . . . . . . . . . . . . . . . . . . . 51
2.2.4 External Loss Data . . . . . . . . . . . . . . . . . . . . 53
2.3 The Dependency Problem . . . . . . . . . . . . . . . . . . . 53
ix