Information Risk

Using Loss Data to Quantify Operational Risk

Patrick de Fontnouvelle Virginia DeJesus-Rueff John Jordan Eric Rosengren Federal Reserve Bank of Boston

April, 2003

Abstract Management and quantification of operational risk has been impeded by the lack of internal or external data on operational losses. We consider newly available data collected from public information sources, and show how such data can be used to quantify operational risk for large internationally active banks. We find that operational losses are an important source of risk for such banks, and that the capital charge for operational risk will often exceed the charge for market risk. Although operational risk capital will vary depending on the size and scope of a bank's activities, our results are consistent with the 2-7 billion dollars in capital some large internationally active banks are currently allocating for operational risk.

The views and conclusions expressed in this working paper have not been subjected to peer review, and should be interpreted accordingly. We thank Fabrizio Leandri for his thoughtful comments on an earlier draft of this paper. We also thank our colleagues in the Federal Reserve System and in the Risk Management Group of the Basel Committee for the many fruitful interactions that have contributed to this work. However, the views expressed in this paper do not necessarily reflect their views, those of the Federal Reserve Bank of Boston, or those of the Federal Reserve System.

I. Introduction. Financial institutions have experienced more than 100 operational loss events exceeding $100 million over the past decade. Examples include the $691 million rogue trading loss at Allfirst Financial, the $484 million settlement due to misleading sales practices at Household Finance, and the estimated $140 million loss stemming from the 9/11 attack at the Bank of New York. Recent settlements related to questionable business practices have further heightened interest in the...