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P2.T7.504. Operational risk capital modeling (Girling)

Nicole Seaman

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Learning outcomes: Compare the basic indicator approach, the standardized approach and the alternative standardized approach for calculating the operational risk capital charge and calculate the Basel operational risk charge using each approach. Describe the modeling requirements for a bank to use the Advanced Measurement Approach (AMA).

Questions:

504.1. Alpha Bank has the following annual gross income (GI) results from the past three years:
  • Year (T-3): + $15.0 million,
  • Year (T-2): + $25.0 million,
  • Year (T-1): + $40.0 million
The alpha factor is 0.15; "α = 15 percent, which is set by the Committee , relating the industry wide level of required capital to the industry wide level of the indicator." Which is nearest to the capital charge under the Basic Indicator Approach, K(BIA)?

a. $2.1 million
b. $4.0 million
c. $6.0 million
d. $17..5 million


504.2. About Basel III's approaches to the calculation of the operational risk capital charge, each of the following statements is true EXCEPT which is inaccurate?

a. A firm that has very strong controls will have the same operational risk requirements as a firm with very poor controls if they have had the same average revenue over the past three years, if they both employ the basic indicator approach (BIA)
b. The standardized approach is similar to the basic approach, except that different business lines have different multipliers. The standardized approach attempts to capture operational risk factors that are missing in the basic approach by assuming that different types of business activities carry different levels of operational risk
c. If a bank has negative income in a year, the basic indicator approach (BIA) and the standardized approaches (SA) can produce an unanticipated result, but the Basel Committee recognizes this possibility such that "If negative gross income distorts a bank's Pillar 1 capital charge, supervisors will consider appropriate supervisory action under Pillar 2."
d. Basel III provides three main approaches to calculating operational risk capital: I. The basic indicator approach (BIA)), II. The standardized approach (SA) including its alternative variation (ASA), and III. The loss distribution approach (LDA)


504.3. In regard to the advanced measurement approach (AMA) to the calculation of operational risk capital, consider the following requirements and stipulations:

I. The model must hold capital for a one-year horizon at 99.9% confidence level; in other words, the capital held must be sufficient to cover all operational risk losses in one year with a certainty of 99.9%
II. All four elements of the framework must be included in the model: internal loss data, external loss data, scenario analysis, and factors reflecting the business environment and internal control systems.
III. There must be an appropriate method for allocating the capital to the businesses to incent good behavior.
IV. Calculations should be made for all seven risk categories
V. The model must capture all expected and unexpected losses, and may only exclude expected losses under certain strict criteria.
VI. The model must provide sufficient detail and granularity to ensure fat-tail events are captured.
VII. The bank must sum all calculated cells or defend any correlation assumptions that are made in its AMA model.

Which of the above are TRUE about the AMA approach?

a. Only I., II., and III. are true
b. Only IV., V., and VI. are true
c. Only I., IV., and VII. are true
d. All of the above are true

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