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Internal Measurement Approach to Operational Risk Capital Charge

March 14, 2001
Toshihiko Mori
Eiji Harada

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Introduction

This paper summarizes the recent discussions on the regulatory framework for operational risk capital charge, incorporating various comments that the Bank of Japan (BOJ) has received since the authors published a discussion paper titled "Internal Risk Based Approach1" on the website of BOJ in August 2000 (August paper).

In the first few sections of this paper, an evolutionary framework for operational risk measurement is briefly outlined, whose basic contents are almost the same as in the August paper. However, terminology and mathematical expressions used in this paper are slightly different from those used in the August paper, reflecting recent dialogues between the industry and supervisors. (For example, an approach that was previously called "Internal Risk Based Approach" in the August paper is now called "Internal Measurement Approach" in this paper2.)

Then, the next few sections focus on the structure of the Internal Measurement Approach (IMA). While the concept of the measurement approach has already been explained in the August paper, this paper describes elements related to the approach as specifically as possible, including the definition of operational loss, methods of parameters estimation, calibration of supervisory scaling factors, and the structure of loss database.

Furthermore, a simplified method on how to incorporate risk mitigation effect by insurance in the regulatory framework is proposed in the final sections. In developing the concept, the authors have conducted various researches on this matter cooperating with professionals from both banking and insurance industry, including actuaries.

  1. "Internal Risk Based Approach, -- Evolutionary Approaches to Regulatory Capital Charge for Operational Risk" by Toshihiko Mori and Eiji Harada, August 2000.
  2. The name of the approach has been changed in order to avoid confusion between the Internal Risk Based approach for operational risk, which is called IRB as an acronym, and the Internal Ratings Based approach for credit risk, which is also called IRB as an acronym.