Value at Risk and Bank Capital Management

134 CHAPTER

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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 55–60% of nonfi nancial risk, while the other 35–40% 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.