A Review of Methods for Quantification of Operational Risk Exposure of Banks

Banks face various risks which may be broadly classified as Credit, Market and Operational risks. The Basel committee for banking supervision provides guidelines for measuring operational risk capital using three different approaches namely Basic Indicator Approach (BIA), Standardized Approach (SA), usually referred to as TSA and Advanced Measurement Approach (AMA). Recently the Standardized Measurement Approach (SMA) is introduced to address the pitfalls of BIA and SA approaches and to remove the incomparability and model complexity of AMA. In this study we provide a rudimentary understanding of operational risk that banks face, the methodologies to compute operational risk and their usefulness. We notice that the same operational risk event can lead to a variety of different kinds of losses of varying magnitudes that may fall in different severity categories. This behavior prompts the researchers to associate a fuzzy membership to the loss severity occurring due to an operational risk event. Also we discuss various approaches to quantify operational risk and their implementation by providing illustrative examples.