Operational Risk Modeling in Financial Services

CHAPTER 19Applications

19.1 INTRODUCTION

Scenario analysis is a key component of the regulatory frameworks for both operational risk loss projections and risk management. In its 2011 supervisory guidelines for the Advanced Measurement Approach¹, the Basel Committee on Banking Supervision (BCBS) states:

A robust scenario analysis framework is an important part of the ORMF² in order to produce reliable scenario outputs which form part of the input into the AMA model.

At the time of writing, the Advanced Measurement Approach has been abandoned as an appropriate method to calculate the regulatory capital of a bank, but the scenario analysis still remains an essential component of an effective stress-testing framework for the Internal Capital Adequacy Assessment Process (ICAAP). This is clearly indicated in the SR 15-18 letter issued by the US Federal Reserve for large and complex institutions (page 41, Appendix 1):

The firm should have transparent and well-supported estimation approaches based on both quantitative analysis and expert judgment, and should not rely on unstable or unintuitive correlations to project operational losses. Scenario analysis should be a core component of the firm's operational loss projection approaches.

For the CCAR³ process, which is the main component of the ICAAP for large US domiciled banks, although banks are not requested to include major operational risk events in the supervisory stress tests as they are considered as idiosyncratic risk events, ...