
House of Lords criticises statistical models for op risk management
Government report throws doubt on the validity of modelling operational risk
LONDON - A report published on June 2 on banking regulation and supervision by the House of Lords Economic Affairs Committee has cautioned supervisors about relying on statistical models alone for measuring operational risk exposure.
The report is largely a critique of the UK's tripartite regulatory regime but a reference to the flaws inherent in modelling operational risk is also buried within it, which has shocked some in the industry. "It's very odd for it to appear in that report," says one source. "It is frustrating also because even though it is very critical of op risk modelling, it doesn't suggest any alternative."
The report reads: "It is not clear that modelling techniques developed to manage portfolios of liquid financial instruments are well-suited to the management of operational risk." Two witnesses are also quoted in the report. One, Jon Danielsson, a reader in finance at the London School of Economics, who provide an oral testimony to the committee, is quoted as saying "operational risk modelling is very dangerous", while William Perraudin, chair of finance at Imperial College, London states "modelling operational risk and setting capital is in some ways hard to justify." However Perraudin also said charging capital against operational risk might generate the right incentives within firms.
The overall recommendation from the report on modelling operational risk is that "in general, financial models designed for use in liquid markets should not be used in the supervision of illiquid markets" but it does not go on to suggest an alternative method of measuring operational risk. It concludes: "Supervisors should base their assessments of operational risk upon a close understanding of the banks they regulate, and not upon statistical models, which cannot substitute for judgement based on analysis." This is what supervisors have been doing under the Capital Requirements Directive anyway since it was implemented, which suggests the report is either seeking to reiterate the importance of supervisors' judgement or sending a message to banks that have placed too much emphasis on modelling operational risk to the detriment of operational risk management.
This story will be covered in more depth in the July issue of OpRisk & Compliance. If you have any comments to make about this please contact Victoria.pennington@incisivemedia.com.
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe
You are currently unable to print this content. Please contact info@risk.net to find out more.
You are currently unable to copy this content. Please contact info@risk.net to find out more.
Copyright Infopro Digital Limited. All rights reserved.
As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (point 2.4), printing is limited to a single copy.
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (clause 2.4), an Authorised User may only make one copy of the materials for their own personal use. You must also comply with the restrictions in clause 2.5.
If you would like to purchase additional rights please email info@risk.net
More on Risk management
Evalueserve tames GenAI to boost client’s cyber underwriting
Firm’s insurance client adopts machine learning to interrogate risk posed by hackers
Wait in the Q: US banks hold back on tariff-related provisions
Lack of data on supply chain vulnerabilities creates challenges for early CECL adjustments
Rising systemic risk demands a new risk management paradigm
Reinsurers need insurance-linked securities to share burden of climate-related catastrophic risk
ECB removes need for governing council to approve CCP facility
New “automatic” facility will require safeguards that are “still being implemented”, bank says
Dodging a steamroller: how the basis trade survived the tariff tantrum
Higher margins, rising yields and stable repo funding helped avert another disruptive blow-up
BoE plans to link system-wide and individual stress tests
Meanwhile, ECB wants to broaden system-wide stress models to include central counterparties
Cyber insurance costs expected to rise as loss ratios worsen
Recent ransomware and tech failure events could feed through into higher premiums this year
The WWR in the tail: a Monte Carlo framework for CCR stress testing
A methodology to compute stressed exposures based on a Gaussian copula and mixture distributions is introduced