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Capital and risk: new evidence on implications of large operational losses

Author

Listed:
  • Patrick de Fontnouvelle
  • Virginia DeJesus-Rueff
  • John S. Jordan
  • Eric S. Rosengren

Abstract

Operational risk is currently receiving significant media attention, as financial scandals have appeared regularly and multiple events have exceeded one billion dollars in total impact. Regulators have also been devoting attention to this risk, and are finalizing proposals that would require banks to hold capital for potential operational losses. This paper uses newly available loss data to model operational risk at internationally active banks. Our results suggest that the amount of capital held for operational risk will often exceed capital held for market risk, and that the largest banks could choose to allocate several billion dollars in capital to operational risk. In addition to capital allocation decisions, our findings should have a direct impact on the compensation and investment models used by large firms, as well as on the optimal allocation of risk management resources.

Suggested Citation

  • Patrick de Fontnouvelle & Virginia DeJesus-Rueff & John S. Jordan & Eric S. Rosengren, 2003. "Capital and risk: new evidence on implications of large operational losses," Working Papers 03-5, Federal Reserve Bank of Boston.
  • Handle: RePEc:fip:fedbwp:03-5
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    References listed on IDEAS

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    Cited by:

    1. Stephen Brown & William Goetzmann & Bing Liang & Christopher Schwarz, 2008. "Mandatory Disclosure and Operational Risk: Evidence from Hedge Fund Registration," Journal of Finance, American Finance Association, vol. 63(6), pages 2785-2815, December.
    2. Chernobai, Anna & Yildirim, Yildiray, 2008. "The dynamics of operational loss clustering," Journal of Banking & Finance, Elsevier, vol. 32(12), pages 2655-2666, December.
    3. Jianping Li & Xiaoqian Zhu & Cheng-Few Lee & Dengsheng Wu & Jichuang Feng & Yong Shi, 2015. "On the aggregation of credit, market and operational risks," Review of Quantitative Finance and Accounting, Springer, vol. 44(1), pages 161-189, January.
    4. repec:gam:jrisks:v:5:y:2017:i:3:p:49-:d:111862 is not listed on IDEAS
    5. Financial Systems and Bank Examination Department, 2007. "The Effect of the Choice of the Loss Severity Distribution and the Parameter Estimation Method on Operational Risk Measurement - Analysis Using Sample Data -," Bank of Japan Research Papers 2007-12-26, Bank of Japan.
    6. Izhar, Hylmun, 2015. "Measuring Operational Risk Exposures In Islamic Banking: A Proposed Measurement Approach," Working Papers 1432-3, The Islamic Research and Teaching Institute (IRTI).
    7. Anna Chernobai & Ali Ozdagli & Jianlin Wang, 2018. "Business Complexity and Risk Management: Evidence from Operational Risk Events in U.S. Bank Holding Companies," 2018 Meeting Papers 1146, Society for Economic Dynamics.
    8. Séverine Plunus & Georges Hübner & Jean-Philippe Peters, 2012. "Measuring operational risk in financial institutions," Applied Financial Economics, Taylor & Francis Journals, vol. 22(18), pages 1553-1569, September.
    9. Imad Moosa & Larry Li, 2013. "The frequency and severity of operational losses: a cross-country comparison," Applied Economics Letters, Taylor & Francis Journals, vol. 20(2), pages 167-172, February.
    10. Tyrone Lin & Chia-Chi Lee & Yu-Chuan Kuan, 2013. "The optimal operational risk capital requirement by applying the advanced measurement approach," Central European Journal of Operations Research, Springer;Slovak Society for Operations Research;Hungarian Operational Research Society;Czech Society for Operations Research;Österr. Gesellschaft für Operations Research (ÖGOR);Slovenian Society Informatika - Section for Operational Research;Croatian Operational Research Society, vol. 21(1), pages 85-101, January.
    11. Linda Allen & Anthony Saunders, 2004. "Incorporating Systemic Influences Into Risk Measurements: A Survey of the Literature," Journal of Financial Services Research, Springer;Western Finance Association, vol. 26(2), pages 161-191, October.
    12. Mizgier, Kamil J. & Hora, Manpreet & Wagner, Stephan M. & Jüttner, Matthias P., 2015. "Managing operational disruptions through capital adequacy and process improvement," European Journal of Operational Research, Elsevier, vol. 245(1), pages 320-332.
    13. Ingo Walter, 2013. "The value of reputational capital and risk in banking and finance," International Journal of Banking, Accounting and Finance, Inderscience Enterprises Ltd, vol. 5(1/2), pages 205-219.
    14. Amandha Ganegoda & John Evans, 2014. "A framework to manage the measurable, immeasurable and the unidentifiable financial risk," Australian Journal of Management, Australian School of Business, vol. 39(1), pages 5-34, February.
    15. Allen, Linda & Bali, Turan G., 2007. "Cyclicality in catastrophic and operational risk measurements," Journal of Banking & Finance, Elsevier, vol. 31(4), pages 1191-1235, April.
    16. Andrea M. Buffa & Suleyman Basak, 2016. "A Theory of Operational Risk," 2016 Meeting Papers 352, Society for Economic Dynamics.
    17. Suren Pakhchanyan, 2016. "Operational Risk Management in Financial Institutions: A Literature Review," International Journal of Financial Studies, MDPI, Open Access Journal, vol. 4(4), pages 1-21, October.
    18. Shafer, Michael & Yildirim, Yildiray, 2013. "Operational risk and equity prices," Finance Research Letters, Elsevier, vol. 10(4), pages 157-168.
    19. Chernobai, Anna & Ozdagli, Ali K. & Wang, Jianlin, 2016. "Business complexity and risk management: evidence from operational risk events in U. S. bank holding companies," Working Papers 16-16, Federal Reserve Bank of Boston.

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    Keywords

    Risk management ; Bank capital;

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