The Need for Measurement

This chapter demonstrates the regulatory and non‐regulatory need for operational risk measurement. It traces the history of the evolution of the Basel Accord. The regulatory capital requirement for operational risks could be calculated using four approaches: the Basic Indicator Approach; the Standardised Approach; the Alternative Standardised Approach; and the Advanced Measurement Approach. The chapter discusses the concept of stress testing, the first of which in the United States was conducted in early 2009 (Supervisory Capital Assessment Program), by the Federal Reserve System to determine if the largest US financial organizations had sufficient capital buffers to withstand a recession. It illustrates why the definition of a risk appetite statement in operational risk requires quantification and modelling. The chapter also presents a discussion with an interesting paradox related to operational risk management at the “micro” and “macro” levels in finance and industry.