CAIIB BFM Unit 15 - How to calculate RWAs for Operational Risk?

CAIIB BFM Unit 15 - How to calculate RWAs for Operational Risk? (Year: 2019)

How to calculate RWAs for Operational Risk?

RWAs for Operational Risk = Capital Charge / 0.09% (If required CAR is 9%)

Operational Risk – Scenario Analysis
It is a term used in measurement of Operational Risk on the basis of scenario estimates.
Banks use scenario analysis based on expert opinion in conjunction with external data to evaluate its exposure to high severity events.
In addition, scenario analysis is used to assess impact of deviations from correlation assumptions in the bank’s Operational Risk measurement framework to evaluate potential losses arising from operational risk loss events.

Operational Risk Mitigation
Insurance cover, if available can reduce the operational risk only when AMA is adopted for estimating capital requirements. The recognition of insurance mitigation is limited to 20% of total Operational Risk Capital Charge calculated under AMA.

Practical Example - AMA approach
Under AMA approach, Estimated level of Operational Risk is calculated on the basis of:
1. Estimated probability of occurrence
2. Estimated potential financial impact
3. Estimated impact of internal control.

Estimated Probability of Occurrence: This is based on historical frequency of occurrence & estimated likelihood of future occurrence. Probability is mapped on scale of 5 as under:

Negligible risk -----1
Low risk-------------2
Medium Risk--------3
High Risk------------4
Very High Risk------5

For Calculation, following formula is used:

Estimated level of Operational Risk = {Estimated probability of occurrence x Estimated
potential financial impact x Estimated impact of internal control} ^0.5
^0.5 implies Under root of whole

Probability of occurrence = 2 (medium)
Probability of Financial impact = 4 (very high)
Impact of Financial control = 50%

[ 2x4x(1-0.5)] ^0.5 = ∫4 = 2 (Low)