What Has Worked in Operational Risk?

Financial institutions have always been exposed to operational risk – the risk of loss, resulting from inadequate or failed internal processes and information systems, from misconduct by people or from unforeseen external events. Both banking supervision authorities and banking institutions have recently showed their interest in operational risk measurement and management techniques. This newfound prominence is reflected in the Basel II capital accord, including a formal capital charge against operational risk, based on a spectrum of three increasingly sophisticated measurement approaches. The objective of this paper is to increase the level of understanding of operational risk within the financial system, by presenting a review of the literature on the modelling techniques proposed for approach such risk in financial institutions. We perform a comprehensive evaluation of commonly used methods, with a view to compare the performance of different estimators and quantitative estimation methods, for implementation of operational risk measurement. We find that there is currently high variability in the quality and quantity of disclosure on operational risk so, as our conclusion, we try to offer instructive and tractable recommendations for a more effective operational risk measurement