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Tackling the over-dispersion of operational risk: Implications on capital adequacy requirements

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  • Feria-Domínguez, José Manuel
  • Jiménez-Rodríguez, Enrique
  • Sholarin, Ola

Abstract

Having proved Basel II to be ineffective to prevent the global financial crisis, Basel III seeks to enhance the resilience of individual financial institutions by strengthening their capital buffer and by building counterbalancing capacity to absorb liquidity shocks. Under this new regulatory framework the increase of capital adequacy ratios is a matter of utmost importance for promoting the soundness and stability of the financial system. With regard to the operational risk, Basel III suggests a greater convergence in the measurement methodologies as well as a higher supervision. To this extent, the objective of this paper is threefold: (i) to test the over-dispersed nature of operational losses; (ii) to capture the extra-Poison variance into the Loss Distribution Approach (LDA); (iii) to assess its potential impact on the capital adequacy requirements (CARs) for operational risk. Our findings point out a higher capital charge associated to the alternative extra-Poisson distributions; even more significant under heavy-tailed scenarios. In consequence, the over-dispersion phenomenon should be addressed very carefully not only by the financial institutions when designing their internal measurement approaches, but also, by the supervisors when validating such models, both ensuring the appropriate specifications to provide with a more realistic capital charges.

Suggested Citation

  • Feria-Domínguez, José Manuel & Jiménez-Rodríguez, Enrique & Sholarin, Ola, 2015. "Tackling the over-dispersion of operational risk: Implications on capital adequacy requirements," The North American Journal of Economics and Finance, Elsevier, vol. 31(C), pages 206-221.
  • Handle: RePEc:eee:ecofin:v:31:y:2015:i:c:p:206-221
    DOI: 10.1016/j.najef.2014.11.004
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    References listed on IDEAS

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    Cited by:

    1. Lu Wei & Jianping Li & Xiaoqian Zhu, 2018. "Operational Loss Data Collection: A Literature Review," Annals of Data Science, Springer, vol. 5(3), pages 313-337, September.
    2. Mili, Mehdi & Sahut, Jean-Michel & Trimeche, Hatem & Teulon, Frédéric, 2017. "Determinants of the capital adequacy ratio of foreign banks’ subsidiaries: The role of interbank market and regulation," Research in International Business and Finance, Elsevier, vol. 42(C), pages 442-453.
    3. Wei, Lu & Li, Guowen & Li, Jianping & Zhu, Xiaoqian, 2019. "Bank risk aggregation with forward-looking textual risk disclosures," The North American Journal of Economics and Finance, Elsevier, vol. 50(C).

    More about this item

    Keywords

    Banking regulation; Operational risk; Capital adequacy requirements (CARs); Over-dispersion phenomenon;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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