January 2023

The Information Value of Past Losses in Operational Risk

Filippo Curti and Marco Migueis

Abstract:

Operational risk is a substantial source of risk for US banks. Improving the performance of operational risk models allows banks’ management to make more informed risk decisions by better matching economic capital and risk appetite, and allows regulators to enhance their understanding of banks’ operational risk. We show that past operational losses are informative of future losses, even after controlling for a wide range of financial characteristics. We propose that the information provided by past losses results from them capturing hard to quantify factors such as the quality of operational risk controls, the risk culture, and the risk appetite of the bank.

Keywords: Banking; Operational Risk; Risk Management

DOI: https://doi.org/10.17016/FEDS.2023.003

PDF: Full Paper

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Last Update: January 06, 2023