Abstract
Abstract The severity and frequency of operational loss events show high variability across the globe. In this paper, we first examine the extent to which the quality of country-level governance measured by the Worldwide Governance Indicators explains cross-country variation of operational losses. We use the comprehensive database of SAS OpRisk Global for the period of 2008–2019 covering 132 countries and 8,144 loss events with a total loss amount of almost 490 billion USD. Our findings indicate that the governance indicators lost their explanatory power over the past decades, which contradicts the academic consensus and calls for new explanatory variables. To find these variables, we hypothesize that the changes are driven by some important megatrends such as economic development and technological advancement, globalization, and sustainability. Accordingly, we propose an extended model where the number of mobile subscribers, the export to GDP ratio, and the poverty headcount ratio were significant for the frequency. For severity, only GDP is a significant and robust explanatory variable. Investors, regulators, and analysts should, therefore, concentrate on these factors if they wish to model, manage, or mitigate operational risks.
Highlights
Operational risk is defined as “the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events” (BCBS 2004: 14)
The governance indicators remain insignificant in the extended model, we identify some additional significant variables, one for each megatrend: the number of mobile subscriptions, export to GDP ratio, and the poverty headcount ratio
To Li and Moosa (2015), we investigate how country-level governance indicators are associated with the severity and frequency of operational loss events across all industries
Summary
Operational risk is defined as “the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events” (BCBS 2004: 14). It is the second most important source of risk for financial institutions measured by the size of the capital requirement set by the regulator (ECB 2017). Non-financial institutions face significant operational risks as well; for them business process management is of top priority. According to the previous literature, operational risk depends on the quality of firm- and country-level governance (Chernobai et al 2011; Cope et al 2012). Better-governed firms operating in better-governed countries are less risky, and are more attractive to investors, which can be reflected in a lower cost of capital
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