8 - High frequency events, low frequency events and the Six Sigma method

Abstract

This chapter addresses to high frequency/low impact (HF/LI) events as well as low frequency/high impact (LF/HI) events to provide the proper conceptual base for scoreboard development. The chapter explains what is needed for system design for operational risk control. Through practical applications of Six Sigma method, the chapter explains what can be done. This chapter explains a methodology and tools that can help in constructing a scoreboard Eigen model beyond the matrix of loss distribution. The method rests on two pillars: a distinction between high frequency operational risk events and low frequency events, which is necessary for planning purposes. The loss distribution approach offers financial institutions the possibility of modeling their operational risk control based on their own loss data under the supervision of the regulators. The difference between loss distribution and those operational risk control approaches that lie lower in the food chain is that the former can allow many degrees of freedom on which a bank can capitalize. This issue of degrees of freedom provides a common ground between loss distribution and the scoreboard.