Measuring and Managing Operational Risk by Paola Leone Pasqualina Porretta & Mario Vellella

Author:Paola Leone, Pasqualina Porretta & Mario Vellella
Language: eng
Format: epub
Publisher: Springer International Publishing, Cham

3.2 Loss Distribution Approach

The Loss Distribution Approach methodology, which the supervisory regulator regulation referred to for the first time in the consultation paper on the new 2001 Basel Accord, 1 consists essentially of separately estimating the two dimensions that are considered determinant of the operational losses and are identified, following an actuarial approach, with the frequency with which the loss event occurs and the severity of the impact in terms of loss amount.

The regulator expected to estimate the frequency and severity distribution functions for each business line/event type combination on an annual time horizon, based on the bank’s internal data and then to aggregate them to obtain the cumulative loss distribution function. For overall risk measure, the simple sum of risk measures for each single business line/event type combination was proposed. The authorities encouraged financial intermediaries to adopt the LDA despite the fact that it posed undue implementation difficulties—mainly due to the complex development of an internal loss dataset—as it stimulated, however, best operational risk management practices.

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