Risk Management and Value Creation in ... - Arabictrader.com

Capital Structure in Banks 199
The spectrum runs from simple, top-down estimations 312 to sophisticated,
bottom-up 313 approaches. 314
In the following sections some best-practice approaches for both event
and business risk are presented and discussed.
Economic Capital for Event Risk In this section we will first define which alternatives
are available to manage event risks. We will find that some of
the exposure to event risk is best “outsourced” to third parties and that
a bank only needs to hold event risk capital for the remaining part; the
derivation of the amount of this type of economic capital will be discussed
subsequently.
The Choice of Risk-Management Options for Event Risk In general, we can distinguish
between two broad categories of losses due to event risk, both of which
can be seen as risks that only have a downside (similar to credit risk): 315
■
■
Relatively small, but fairly frequent event losses resulting from occasional
human or technical errors in typical banking processes
Infrequently occurring major event losses that endanger the existence
of the bank due to their substantial impact on the capital resources
of the institution
Trying to quantify these risks increases the awareness of their existence. 316
By not ignoring or covering up these types of risks (and hence the fact
that mistakes can and do happen), a bank can learn valuable lessons 317 and
can devote adequate resources to trying to avoid experiencing such event
losses.
As we have seen, there are other options for managing operational/event
risk beyond holding economic capital. These options can be divided into
three categories:
312 For instance, some banks calculate the capital they would like to hold against
operational risks as the difference between their book or regulatory capital and the
amount of (economic) capital that they calculated was necessary to hold against market
and credit risk.
313 For instance, some banks take data from so-called event risk databases and (Monte
Carlo) simulate the implied distributions to determine the probability of extreme
losses via a statistical/actuarial approach.
314 For a full description of currently used methods for estimating economic capital
see Wills et al. (1999), pp. 93–97.
315 See Basle Committee on Banking Supervision (1998), p. 4.
316 See Basle Committee on Banking Supervision (1998), p. 2.
317 See Lam and Cameron (1999), p. 84.