Correlations and Systemic Risk in Operational Losses of the U.S. Banking Industry

Abstract

Using supervisory operational loss data of the U.S. banking industry, we analyze correlations among operational losses within banks and across banks. We find evidence of relatively high correlations among tail losses of different operational risk types within banks. The median of these correlations for the key operational risk types is around 30% and exceeds 50% for some banks in our sample. Our results contrast with the previous literature which documents that correlations are in the range of 5-10% and typically do not exceed 20%. Further, we show numerically that not accounting for higher correlations among tail losses results in the significant underestimation of operational risk. In addition, we investigate correlations of operational losses across banks. We estimate these correlations to be 42% on average for large banks in our sample of data. This finding suggests the presence of systemic risk from the simultaneous occurrence of operational tail losses in different large banks.