The effect of stressed economic conditions on operational risk loss distributions

Abstract

The depth and duration of the credit crisis has highlighted a number of problems in modern finance. Banks have been accused of excessive risk taking, rating agencies of severe conflicts of interest, central banks of neglecting the inflation of asset price bubbles and national supervisors of lax regulatory controls. Credit and market losses have been considerable. Operational losses have also surged as surviving corporates merge or acquire less fortunate ones without the requisite controls. Furthermore, as more jobs get made redundant it is believed that people are getting forced to play their hand to get involved in internal fraud as their sources of income have dried up drastically and stealing from the institution seems to be their last resort.. The main objective of this paper is to establish if there has been a change in the nature of operational risk with regards to the number of operational losses as well as their impact pre and during the crisis. The way in which operational losses have been affected will be presented and a comparison will be made between operational loss characteristics pre and during the crisis. Some of the main findings of this paper were that operational losses showed little change in frequency, but showed a significant increase in severity, meaning that their financial impact has been more severe during the crisis. Therefore it is quite safe to say that the financial crisis most definitely had an impact on operational risk as the impact of operational losses became much more severe.