134 CHAPTER
5 Operational Risk and Business Risk
types.
5
Removing these dependence assumptions results in a decline in the median gross
income ratio from 12.81% in the second panel to 9.46% in the third panel.
In summary, recent regulatory exercises have shown that U.S. banks have made
progress in measuring their exposure to operational risk. In QIS-4, 14 banks provided
exposure estimates based on an AMA-like framework. The operational risk exposure
estimates generally fell in the range of 8%–12% of gross income, or a bit below estimates
using a basic indicator or standardized approach. Signifi cant variation in AMA frame-
works continues to exist, with some framework components (e.g., dependence assump-
tions) having a measurable impact on exposure estimates.
5.6 The Role of Measures of Business Risk and Earnings
at Risk
Whereas market, credit, and operational risks are usually given greater attention because
they are also associated with a specifi c minimum capital requirement, business risk also
deserves to be carefully considered. Business risk is defi ned here as the risk of losses
deriving from earnings volatility for fee-based businesses, such as asset management,
brokerage, corporate fi nance advisory, and payment services. This concept can also be
applied to businesses that may apparently be linked to market risks (e.g., sales departments
for structured products) but do not directly undertake market risks and are remunerated
and evaluated mostly based on the business volume they generate. Businesses such as
asset management and advisory do not usually imply a direct market or credit risk for the
bank, even if they imply operational risk. Apart from events that may cause operational
risk losses, however, these businesses usually generate an important but unstable contribu-
tion to a bank’s P&L. Please note that business risk should be identifi ed not with the vola-
tility of revenues, but with profi t volatility. As a consequence, business risk should not
depend only on how volatile a business unit’s volumes and revenues may be, but also for
instance on its ability to adapt its cost base to changes in business volumes.
It is important to note that business risk has a minor impact if the only concern is to
avoid the short-term default of a bank (which may explain why regulators did not intro-
duce any formal requirement for business risk). Intuitively, the book capital that may be
destroyed by a fee-based business unit in a single year can hardly threaten the bank’s
survival in the short term. Instead, business risk’s relevance is much higher if the bank
wanted to measure the potential impact of different businesses on the market capitaliza-
tion that could be destroyed under adverse scenarios. Hence, from the point of view of
market capitalization at risk, which was introduced in Chapter 2, business risk may be
crucial.
According to a top-down analysis over a sample of U.S. banks and to a survey of 11
large international banks, Kuritzkes (2002) estimates that business risk may account for
around 5560% of non nancial risk, while the other 3540% would be linked to event-
driven operational risk. Figure 5-2 provides some data about the weight of business risk
over total risk capital and the ratio between estimated risk capital for business risk and
operational risk in some of the relatively few major international banks that disclose their
business risk estimates. Despite the variations in the estimates from bank to bank, the
5. Because some banks included dependence assumptions while others did not, we use a zero-correlation
assumption across business lines and event types for all AMA banks in this panel This is done purely to achieve
comparability and should not be interpreted as an indication that we believe there is no dependence across business
lines and event types.

Get Value at Risk and Bank Capital Management now with O’Reilly online learning.

O’Reilly members experience live online training, plus books, videos, and digital content from 200+ publishers.