Challenges and pitfalls in measuring operational risk from loss data

Abstract

Under the advanced measurement approach of the Basel II Accord, banks are required to measure their total annual operational risk exposures at the 99.9th percentile of the loss distribution. We examine the possibility of meeting this measurement standard given the amount of operational loss data that is currently available from either internal or external sources. We also look at some of the difficulties that arise in applying the loss distribution approach to computing operational risk exposures, as well as in validating the capital models. Finding many of these problems insurmountable, we suggest some changes to the regulatory framework that would circumvent these difficulties.