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P2.T7.306 Operational risk (Basel)


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306.1. Acme Bank is a small bank with three business lines (corporate finance, commercial banking, and asset management). The bank has experienced rapid growth in the last three years, as its annual gross income grew from -$7.0 million (three years ago) to $71.0 last year:

Roger the analyst wants to apply a Basel approach to estimate Acme's Operational Risk Charge (ORC). First, he estimates the capital charge under the basic indicator approach (BIA) where the alpha factor (percentage) is equal to 15%. Then he assumes the standardized approach (SA) with the standard beta factors as given above. For Acme Bank, what is the reduction in the charge implied by a shift from the BIA to SA approach?

a. No reduction
b. $2.8 million
c. $4.7 million
d. $9.0 million

306.2. Each of the following is true about the Basel II/III approach to operational risk EXCEPT which is false?

a. Basel's definition of operational risk includes certain external risks; such as external fraud, legal risk, theft and natural disaster; but excludes strategic and reputational risk
b. Basic indicator (BIA) and standardized (SA) are top-down approaches while advanced measurement (AMA) is a bottom-up approach
c. Standardized (SA) and alternative standardized approaches (ASA) both implicitly assume a perfect correlation between business lines
d. Compared to Basel II, Basel III phases out the BIA approach and disqualifies Tier 2 capital as eligible for the operational risk charge

306.3. Each of the following is true about the Basel advanced measurement approach (AMA) to its operational risk charge (ORC) requirement for regulatory purposes EXCEPT which is false?

a. The bank must calculate its regulatory operational risk charge (ORC) as the sum of expected (EL) and unexpected loss (UL) unless it can show it captures EL in its internal business practices
b. The AMA quantitative standard includes an operational risk VaR (OpVaR = UL + EL) with 99.9% confidence over a one-year horizon which is "comparable to that of the internal ratings-based approach for credit risk"
c. While insurance is "an essential risk mitigant from an economic capital, due to a lack of methodological consistency within a regulatory framework," insurance CANNOT be used to offset the AMA-approach ORC "
d. Although AMA has quantitative standards, AMA neither specifies any particular distributional assumption for loss frequency or severity; nor technically even requires heavy-tailed distribution(s)