Operational Risk Is More Systemic than You Think: Evidence from U.S. Bank Holding Companies

Abstract

While operational risk is generally perceived as idiosyncratic with limited systemic implications, we document that operational risk significantly threatens financial stability. Using supervisory data on large U.S. bank holding companies (BHCs) over 2002:Q1-2016:Q4, we find operational losses increase systemic risk through both direct channels that impair market values of loss- experiencing BHCs and spillover channels to related institutions. Findings are driven by tail events, are more pronounced for systemically important and closer-to-distress BHCs, and vary by business lines, event types, and financial and economic environments. Results add to the operational risk and systemic risk literatures, and have key policy implications.