Quantification of operational risk for Basle II

A major business in the European banking sector adopted a pro-active stance towards the Basle II capital requirements for operational risk. A project was launched to analyze and quantify their operational risk with the goal of determining the economic capital required to support it. They wanted to demonstrate to regulators the adequacy of their capital base and to better manage their risks.

• Zurich consultants began by facilitating risk profiling workshops and helping to structure the catalogue of operational risks.
• The specialized banking operations have a strong dependency on Information Technology which meant that special attention had to be paid to the interactions of systems with business functions. In collaboration with the bank, Zurich consultants developed a matrix model of the interactions which ultimately supported their quantification. A major benefit of this approach was that it took care of correlations in a natural and intuitive way.
• Zurich’s consultant actuaries analyzed the bank's historical losses and derived a model from them. This model served as a platform for extrapolating the range of historical losses to larger losses with return periods of many decades.
• Other risk scenarios were quantified using the bank’s expert opinions, which were captured in Zurich’s standard "Quant 1" software tool. This system was also used to aggregate all risk scenario quantifications into one global simulation of operational risk.
• Finally, Zurich consultants helped to allocate the overall risk capital to individual business units. This was designed to set appropriate financial incentives for further investment in risk mitigation.

The project resulted in a strong buy-in to the process across the bank’s operating units and a comprehensive quantification of Operational Risk and the capital needed to support it. This puts the bank in an excellent position to assess and monitor their risk exposure in the future and to manage their risk portfolio from a financial, risk/reward perspective.