The San Francisco-based bank, Jones reports, is building a mathematical model for calculating this capital estimate using analytics software from SAS (Cary, N.C.). The SAS software has some elements of Basel II requirements and financial institution "range of practice" best practices built into it. (The Basel II Accord Implementation Group's Operational Risk Subgroup obtained its range of practice from members' supervisory work, benchmarking exercises, discussions with bank management and other sources.)
"It's very helpful; many banks reference the range of practice to see what others are doing in particular areas of the model," Jones notes, adding that the SAS software also has other built-in features, such as the ability to correlate risk across different event types, that developers otherwise would have to create from scratch.
The mathematically intense Value at Risk model is being developed in-house by six quantitative analysts at the bank. It will consider best-case and worst-case scenarios, according to Jones. "Our risk models are complex because it's more of a probabilistic model as opposed to a regression model," he explains.
Jones points out that an internal database feeds internal loss data into the model. The external loss data comes from the American Bankers Association. The results of the operational risk model will be fed into a broader risk model that looks at all the risk-weighted assets of the bank and considers credit and market risk as well as operational risk.
The biggest benefit to the bank of implementing this new model will be safety and soundness from a capital adequacy perspective, Jones asserts. "That's really what this is all about -- how much capital does a bank need to hold to absorb unanticipated losses. That's the primary goal -- whether it's market risk, credit risk or operational risk," he says, noting that the model also will help the bank reconsider its processes and controls and perhaps make risk management changes as a result.
TARGETING MARKET RISK
For its part, Amsterdam-based ING (US$1.3 trillion in assets) currently is focused on controlling market risk, according to Valerie Benichou, project manager, market risk management and product control, ING Belgium. "Efficient market risk management is a top priority for ING," she says. "To be compliant with Basel II standards and rules, we need to improve our market risk control and link market and counterparty controls. We're making a lot of effort now and will do much in the future to be compliant with this standard."
Like many U.S. banks, ING plans to implement before the end of the year stress VAR models -- mathematical modeling of the bank's Value at Risk taking into account difficult market conditions such as those that existed during the subprime crisis. "The objective of stress VAR is to try to estimate the right level of capital to be sure that we'll have sufficient capital to face even a worst-case scenario in the markets," Benichou explains.