Operational Risk and Basel II

Abstract

The management of operational risk is not a new concept in the banking industry. Operational risks such as external fraud, internal fraud, and processing errors have had to be managed since the beginning of banking. Traditionally, these risks were managed using insurance protection and audit. Globalisation, complex financial products and changes in information technology, combined with a growing number of high-profile operational loss events worldwide have increased the importance of operational risk management for the banking industry. This has prompted regulators to decide that banks have to set aside risk capital to cover operational risk losses. The Basel Committee on Banking Supervision (BCBS) began the discussions on operational risk management in 1998 leading to the inclusion of operational risk capital requirements into the new international regulatory framework, Basel II, developed during 2001–2006. Currently, major banks are undertaking quantitative modelling of operational risk to satisfy these requirements. This chapter gives an overview of the Basel II requirements for operational risk management, several important loss data collection exercises conducted by regulators in different countries and proposed modelling approaches.