Quantifying Regulatory Capital for Operational Risk

The proposed New Accord (Basel II) established by the Basel Committee on Banking Supervision calls for an explicit treatment of operational risk. Banks are required to demonstrate their ability to capture severe tail loss events. Value at risk is a risk measure that could be used to derive the necessary regulatory capital. Yet operational loss data typically exhibit irregularities which complicate the mathematical modeling. It is shown that traditional modeling approaches, including extreme value theory, reach their limits as the structure of operational loss data is barely in line with the modeling assumptions.