adaptation of bank'sx risk management model to the new basel ...

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VADYBA / MANAGEMENT. 2006 m. Nr. 2(11)
ADAPTATION OF BANK‘S X RISK MANAGEMENT MODEL TO THE NEW
BASEL CAPITAL ACCORD USING ALGORITHM BASED ON PAIRED
COMPARISON
Algimantas Gaulia, Irena Ma�erinskien�
Commercial banks face new challenges in risk management as they adapt their risk management systems to the New
Basel Capital Record, or Basel II. Basel II offers choice of alternative risk management tools, ranging from simple risk
weight approaches to advanced statistical data based approaches. Banks have to choose optimal for them risk management
methods and implement them. One method for choosing the alternatives is studied in this paper. Authors develop an
algorithm, which is based on comparing compliance of alternative methods with criteria that have different weights that are
determined by paired comparison method. Applying this algorithm to adapt risk management model of small Lithuanian
bank X to Basel II showed that statistical data based risk management tools can be used to improve bank’s risk
management, but in combination with other risk management methods and only if the risk is significant so that the benefits
from adapting them would be higher than the cost of adoption and usage.
Key words: Basel II, risk management, paired comparison.
Introduction
One of the main issues for commercial banks is adoption of revised International Convergence of Capital
Measurement and Capital Standards, or Basel II, that is set out here to be available for implementation as of
yearend 2006 (but banks can opt to apply current rules until end 2007). However, the Basel Committee of
Banking Supervision feels that one further year of impact studies or parallel calculations will be needed for the
most advanced approaches, and these therefore will be available for implementation as of year-end 2007. The
new Basel Accord will be implemented in the European Union via the Capital Requirements Directive (CRD).
Many commercial banks have to make a decision of how to adopt their risk management models
according to Basel II. In this light, using paired comparison method to choose one of the alternatives may be
appropriate, that’s why the authors of this paper created an algorithm based on paired comparison method and
used it to choose alternatives in adapting Bank’s X, small-sized Lithuanian bank’s risk management model to
Basel II.
1. Key risks and risk management models
There are many banking risks. Most common approach is to group banking risks to credit risk, liquidity
risk, market risk and operational risk.
Credit risk
Credit risk is described as the risk to have losses because counterparty is not capable to carry out its
obligations according to the terms of the agreement. Sometimes losses occur even when the counterparty does
not breach the contract, but there are certain signs showing increasing probability of borrower’s insolvency
(e.g. downgrade in credit ratings of the borrower).
Credit risk is one of the key risks for the banks as failure to properly evaluate it may lead to insolvency
and bankruptcy. Aggregated stress testing of Lithuanian banks results of the yr. 2002 showed that banks
consider credit risk to be the most important risk, constituting over 62% of possible losses [6].
Basel II suggests 3 alternative approaches for credit risk management – Standard approach, Foundation
Internal Ratings Based (F-IRB) approach and Advanced Internal Ratings Based (A-IRB) approach. Using
standard approach, capital coverage is calculated by applying certain risk weights to certain balance sheet
items. Internal ratings based approaches calculated capital coverage as function of PD (probability of default),
LGD (loss given default), EAD (exposure at default) and M (maturity). The difference between F-IRB and A-
IRB is that under F-IRB approach banks rely on more supervisory estimates than under A-IRB approach [3].
Besides alternative approaches for capital coverage calculation, classic credit risk management tools
such as limit systems, credit scoring procedures, loan assessment procedures, risk diversification rules, etc. are
necessary to use to keep credit risk as low as possible.

VADYBA / MANAGEMENT. 2006 m. Nr. 2(11) 49
Table 1. Difference between F-IRB and A-IRB approaches
Parameter F-IRB approach A-IRB approach
PD Estimated by bank Estimated by bank
LGD Set by supervisory institution Estimated by bank
EAD Set by supervisory institution Estimated by bank
M Set by supervisory institution Estimated by bank
Liquidity risk
Liquidity risk is also risk of key importance to commercial banks as failure to properly manage this risk
may result in insolvency of the bank. Liquidity risk involves the possibility that earnings or capital will be
negatively affected by an institution’s inability to meet its obligations when they come due. Liquidity risk is
the risk that the financial institution cannot settle an obligation for full value when it is due (even if it may be
able to settle at some unspecified time in the future). Liquidity problems can result in opportunity costs,
defaults in other obligations, or costs associated with obtaining the funds from some other source for some
period of time [7]. In most cases, liquidity risk is the outcome of other risks such as credit, strategic,
reputation, interest rate and counterparty risk. For instance, when important large customer becomes default,
bank may have difficulties in meeting its obligations. Additionally, liquidity risk comes in the normal course of
business, usually as long-term assets are financed by short-term obligations.
Liquidity risk is managed by analysing liquidity gaps (simple and marginal), using cash matching
approach by setting limits for absolute or relative liquidity gaps, making projections of future cash flows,
scenario testing. Value-at-risk (VaR) techniques using statistical data may be used for these purposes.
Market risk
Market risk is the risk of adverse deviations in price of financial items (equities, bonds, FX deals,
derivatives, etc.) [4]. Market risk includes currency risk, interest rate risk, equity or debt security price risk etc.
market risk may result both in positive and negative effects. In capital charge calculation, only the negative
effects are taken into account. Main goal in market risk management is to reliably estimate likely price
fluctuations and to take decision whether to take the risk or to reduce it. Limit systems, gap analysis,
correlation analysis, instrument sensitivity analysis, market volatility analysis can be used for market risk
management. The risk can be reduces by portfolio diversification or hedging using derivative financial
instruments (swaps, forwards, options, etc.). Market risk can be measured by using risk weights or by using
value-at-risk approaches. It’s important to note that in order to reach best risk management results, VaR-based
approaches should be used in combination with other risk management methods as VaR models rely on certain
assumptions, not every time equilibrium between the accuracy and operativity is reached, output on the same
data using different VaR models may vary substantially.
Operational risk
The definition of operational risk varies considerably since the list of factors causing operational risk is
incomplete and constantly growing due to increasing complexity of business. Basel Committee on Banking
Supervision defines operational risk as the risk of direct or indirect loss resulting from inadequate or failed
internal processes, people, and systems, or from external events [1]. Risk may actualise in technical level (IT
system or risk measurement system inefficiency) or in organizational level (lack of procedures, non-adequate
organization of risk monitoring and reporting) [4]. Basel Committee on Banking Supervision considers
operational risk to be of high importance, that’s why Basel II demands capital charge calculation for
operational risk. Stress testing of Lithuanian banks in 2002 showed that Lithuanian banks consider that losses
from operational risk would make 5% of all the losses [6]. Quantitative Impact Study 3 (QIS 3) calculation
shows that operational risk capital charges increase regulatory capital by 5-15% [2].
As it is impossible to name all the risks, it is suggested to determine factors causing operational risk.
After that the following algorithm can be used in determining whether to ignore the risk factor, or to take
action.

50
Do they require
management?
N
Risk is taken
Identification of factors
causing risk
Y Are these factors
N
significant?
Y
What risk management
mehods exist?
Risk management method is
chosen and applied
Fig. 1. Possible ways of reacting to risk
VADYBA / MANAGEMENT. 2006 m. Nr. 2(11)
No action is taken while
significance does not increase
In order to determine whether significant factors require management decision-matrix presented in the
table below can be helpful.
Table 2. Decision-matrix for operational risk management
Probability of
the event
Expected losses
Minimal
Maximal
(Adapted from [5])
Minimal Maximal
No action is taken Risk is managed
Risk is managed if
cost of adoption of the
risk management
method is less than
expected losses
Risk is managed
Basel II suggests 3 alternative methods to quantify operational risk: Basic Indicator approach (gross
income multiplied by risk weight), the Standardized approach (multiplying gross income from eight business
lines by risk weights), or the Advanced Measurement approach (bank uses its own developed techniques with
the consent of supervisory institution after meeting qualitative requirements) [3].
2. Selection and assigning weights to criteria for comparison of alternative methods
As selecting best suitable risk management approaches needs qualitative analysis, in order to make
selection of the alternative methods quantified, adapted paired comparison method can be used. Five criteria
characterizing methods are designated, and they all are compared against each other, for every pair of the
criteria assigning 10 points. Results of this process are described below.

VADYBA / MANAGEMENT. 2006 m. Nr. 2(11) 51
Pair of
criteria
List of criteria:
A. Accuracy of the method
B. Cost of the adoption of the method
C. Cost of using the method
D. Reduction of losses when the method is applied
E. Changes in capital charges calculated using the method.
Result of the
comparison of
the criteria
Table 3. Comparison of pairs of criteria
Reasoning of the result
A-B A – 2 B – 8 If bank does not have enough funds to adopt the most accurate approach, it can’t adopt it. But
if adoption of two alternative approaches costs the same, the accurate one should be chosen
A-C A – 5 C – 5 If model A is more accurate than model B, and cost of using the model is the same or model
A using cost is lower than model B using cost – model A should be chosen; if the accuracy of
models A and B is the same and model A using costs are higher – model B should be chosen;
if the accuracy of model A is higher than the accuracy of model B, but the cost of using
model A is higher than the cost of using model B – choice of the model would depend on
other factors.
A-D A – 3 D – 7 If the model leads to reduction of the cost, it is more important than the accuracy of the model
since the purpose of risk management is reducing the cost; despite that, criteria A gets 3
points because overestimating criteria D can lead to too liberal approach towards the risk
management which under negative circumstances may result in losses later.
A-E A – 7 E – 3 Capital is the most expensive of all resources; despite that, purpose of risk management is not
to reduce capital charges, but to calculate them as accurately as possible and reasonable
B-C B – 5 C – 5 Net present value of projected cash flows should be used. If NPV of alternatives is equal,
selecting better method depends on other factors.
B-D B – 6 D – 4 Adoption are usually clear and easy to calculate, and positive outcome from reduction of
losses usually depends on certain assumptions i.e. is less clear
B-E B – 3 E – 7 If bank is financially capable to adopt a model, which would reduce capital costs, and the
NPV of reduction of capital cost is higher than the NPV of adoption costs, it would be useful
to adopt the model
C-D C – 5 D – 5 If using costs of the model were P, reduction of losses when model was applied were K,
model – M, selection between model A & B would be the following:
PA – PB > KA – KB, –> MB
PA – PB < KA – KB, –> MA
PA – PB = KA – KB, –> choice depends on other factors
C-E C – 6 E – 4 In case adoption cost and positive effect from changes in regulatory capital were equal,
selection would depend on other factors. But adoption cost can be measured more reliably.
D-E D – 7 E – 3 As reduction in capital costs does not always mean better risk management, projected
positive effect from cost reduction is more important
The results of all paired comparisons of the criteria are presented in paired comparison matrix.
Table 4. Result of paired comparison of criteria
Criteria A B C D E Total
A 2 5 3 7 17
B 8 5 6 3 22
C 5 5 5 6 21
D 7 4 5 7 23
E 3 7 4 3 17
3. Algorithm for assessment and selection of risk management methods
Risk management methods used in Bank X will be assessed by using this algorithm (Fig. 2.)

52
Improvement is rejected
Y
No changes are applied
N
Is the risk management model adequate, meets the criteria
of Basel II and it is impossible to improve it?
N
Are likely benefits from the
improvement of the model higher
than the cost of adoption?
Y
Improvement is adopted
VADYBA / MANAGEMENT. 2006 m. Nr. 2(11)
N
Are there any
alternative methods for theimprovement
of the model?
Fig. 2. Algorithm for assessment of risk management methods
Y
Algorithm depicted in picture 2 for selection
of the best alternative is applied
If there are alternative methods available, optimal method for bank X is selected by using the algorithm
presented below. Alternative risk management methods will be compared according to their compliance to the
criteria presented in section 2, above. Compliance to the criteria (CC) is measured with a scale ranging from 0
(totally does not comply) up to 10 (totally complies). Criteria will have influence to overall result (CI) such as
stated in paired comparison matrix. Score for the model (SM) is calculated using the formula below.
SM = (CC/10) * (CI/100); (1)
The model that has highest SM is chosen.
Y
START
Ar modelis Does the atitinka model Basel meet II N
the requirements of
sutarties Basel reikalavimus? II?
Assessment of how model matches criteria is performed
Model is selected
The score for the model is calculated
Is model’s score highest compared to the
alternative models for management of the
same risk?
Y
FINISH
Model is rejected
N
Steps are applied for all
models
Fig. 3. Algorithm for choosing one of the alternative risk management methods

VADYBA / MANAGEMENT. 2006 m. Nr. 2(11) 53
4. Selection of the models for credit risk management
Bank X uses classic risk management methods - credit limit system, counterparty risk management
systems, risk diversification rules. These tools are efficient, comply with Basel II and are suitable for further
usage. But calculation of capital charges for credit risk of bank X does not comply with Basel II requirements,
that’s why the choice between Standard, F-IRB and A-IRB approaches will have to be made.
Compliance of alternative approaches with Criterion A (accuracy of approaches)
A-IRB approach will without doubts comply with criteria A since all the parameters are set by the bank,
using actual statistical data. F-IRB approach will comply less with this criteria, but still some of the parameters
will be set by using actual statistical data. The accuracy of Standard approach is doubtful, since statistical data
do not have direct influence to the quantification of risk. Compliance with criterion A can be assessed the
following:
A-IRB: 10/10 F-IRB: 6/10 Standard: 1/10.
Compliance of alternative approaches with Criterion B (cost of the adoption)
Since bank X currently uses approach similar to Standard approach, and the adoption of Standard
approach would be just a modification of current approach, the cost of adoption of Standard approach would
be lowest. Creating statistical databases costs a lot of money, and due to size of Lithuanian banking market,
joint databases are necessary for the gathering of necessary information. The more variables are assessed in the
model, the more data needs to be gathered, and the more difficult and expensive is the adoption of the model.
That’s why adoption of A-IRB approach would be the most costly (this also is mentioned in many studies).
Rating of approaches according their compliance with criterion B is the following:
A-IRB: 0/10 F-IRB: 4/10 Standard: 10/10.
Compliance of alternative approaches with Criterion C (cost of using the approach)
The more complicated the model is, the more statistical data is used, and the higher is the method using
cost. Cost of using standard method would be lowest as the bank would not increase it’s current workload.
Internal ratings based methods require statistical data, which should be obtained from internal, or external
databases that would result in higher cost. Rating of approaches according their compliance with criterion C is
the following:
A-IRB: 0/10 F-IRB: 4/10 Standard: 10/10.
Compliance of alternative approaches with Criterion D (reduction of losses when the approach is
applied)
The Standard approach is just the modification of current approach, so reduction of losses when this
approach is applied should not be expected. Internal ratings based approaches mean qualitative improvement in
bank’s credit risk management. Basel II implies qualitative criteria that should be met in order to apply internal
ratings based approaches, and compliance with these criteria will surely help increase the quality of decisionmaking
and reduce the losses due to improper credit risk management. As A-IRB approach uses the most
statistical data and banks must meet strictest requirements to adopt it, this approach scores highest in
compliance with this criterion. F-IRB approach would still mean qualitative improvement, so it gets more than
average CI score. Rating of approaches according to their compliance with criterion D is the following:
A-IRB: 10/10 F-IRB: 8/10 Standard: 0/10.
Compliance of alternative approaches with Criterion E (changes in capital charges calculated
using the method)
Standard approach would result in highest capital charges. Two main arguments back-up this statement:
first, most of Lithuanian enterprises are too small to use the services of credit rating agencies, and even if they
got rated, they most likely would get credit rating lower than Lithuanian sovereign credit rating (which
currently is at lowest investment grade), which will result in risk weight of 100% or even higher. Second,
results of QIS 3 show that adoption of standard approach leads to highest capital charges compared to internal
ratings based approaches. Of the F-IRB and A-IRB approaches, capital charges are lower for A-IRB approach
[2].
Rating of approaches according their compliance with criterion E is the following:
A-IRB: 10/10 F-IRB: 8/10 Standard: 0/10.

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Selection of the approach
After calculation of compliance of alternative approaches with the criteria, the score for the model (SM)
is calculated for each of the alternative approaches in the Table 5.
Approach
Table 5. Result of comparison of credit risk management approaches
A
(max. 17)
B
(max. 22)
C
(max. 21)
SM
D
(max. 23)
E
(max. 17)
Standard 1.7 22.0 21.0 0.0 0.0 44.7
F-IRB 10.2 8.8 8.4 18.4 13.6 59.4
A-IRB 17.0 0.0 0.0 23.0 17.0 57.0
As the table shows, bank X should choose F-IRB approach for assessment of credit risk.
5. Selection of the models for liquidity risk management
Bank X uses liquidity gaps, projected cash flows and internal liquidity limits for liquidity management.
The liquidity risk management system meets its objectives, but there is room for possible improvement: bank
X could possibly adopt VaR measures to make projections of customer cash flows. This would help to make
cash flow planning more precise that could result in less strict internal liquidity limits and select more
profitable opportunities for the investment of spare funds. Additionally, these measures would allow analysing
not only retrospective, but also prospective liquidity gaps. As this would result in improvement of bank’s X
liquidity management system and projected benefits are higher than the projected costs, this improvement
should be adopted.
6. Selection of the models for market risk management
Currently, bank X uses interest rate gap method and internal limits for interest rate risk management,
additionally by projecting changes in market rates and the impact of these changes to bank’s profitability. Of
the other market risks, currency risk is the most important to the bank X: in yr. 200X, income from operations
with foreign currency and derivatives made 80% of bank’s trading income. There are aggregate and single
open currency limits set by the Bank of Lithuania, additionally stricter internal open currency limits for the
daytime and end of day are imposed. Excess positions are hedged using derivative financial instruments. Other
market risks are not of high importance to the bank X: in yr. 200X, income from operations with bonds and
equities made 4% of gross income, bonds and equities made just about 1% of bank’s X assets. Bank uses limits
in order to diversify equity/bond portfolio. Capital charges for market risks are calculated by applying risk
weights.
Diversification and limits for financial items is effective and has no alternatives, but the calculation of
market volatilities and capital charges could be made more accurate by adopting VaR measures. That’s why
algorithm described above will be use to select better alternative of calculation of capital charges – either risk
weights, either VaR measures. Since the most important market risks for bank X are interest rate risk, currency
risk and equity risk, the compliance of these risks with the criteria will be measured separately.
Compliance of alternative approaches with Criterion A (accuracy of approaches)
VaR approaches rely on statistical market data, risk weight approaches do not directly link to market
movements, that’s why rating of approaches according their compliance with criterion A is the following:
Interest rate risk: risk weight approaches: 0/10 VaR approaches: 10/10.
Currency risk: risk weight approaches: 0/10 VaR approaches: 10/10.
Security risk: risk weight approaches: 0/10 VaR approaches: 10/10.
Compliance of alternative approaches with Criterion B (cost of the adoption)
Using risk weight approaches would require no additional costs while adoption of VaR approaches
would have costs. Rating of approaches according their compliance with criterion B is the following:
Interest rate risk: risk weight approaches: 10/10 VaR approaches: 0/10.
Total

VADYBA / MANAGEMENT. 2006 m. Nr. 2(11) 55
Currency risk: risk weight approaches: 10/10 VaR approaches: 0/10.
Security risk: risk weight approaches: 10/10 VaR approaches: 0/10.
Compliance of alternative approaches with Criterion C (cost of using the approach)
It is the same situation as in compliance with previous criterion:
Interest rate risk: risk weight approaches: 10/10 VaR approaches: 0/10.
Currency risk: risk weight approaches: 10/10 VaR approaches: 0/10.
Security risk: risk weight approaches: 10/10 VaR approaches: 0/10.
Compliance of alternative approaches with Criterion D (reduction of losses when the approach is
applied)
Situation is different for different types of risks: for interest rate and currency risk management
purposes, adoption of VaR measures would give information that would help in decision-making process, it
would help to set adequate limits and apply appropriate tactics. While in case of security risk, due to the small
size of portfolio, it is not likely that possible positive effects would outweigh the cost of the adoption. While
the trading equity/bond portfolio is this small, it is better to allocate the resources towards other fields of
activity. Rating of approaches according their compliance with criterion D is the following:
Interest rate risk: risk weight approaches: 0/10 VaR approaches: 10/10.
Currency risk: risk weight approaches: 0/10 VaR approaches: 10/10.
Security risk: risk weight approaches: 7/10 VaR approaches: 3/10.
Compliance of alternative approaches with Criterion E (changes in capital charges calculated
using the method)
Calculations done by the author show that as for currency risk, capital charge calculated using historical
VaR would be approximately 2 times lower than capital charge calculated using risk weights. If the bank does
not specialize in risky operations, usually calculation by risk weights results in higher capital charges than
calculation using VaR.
Rating of approaches according their compliance with criterion E is the following:
Interest rate risk: risk weight approaches: 0/10 VaR approaches: 10/10.
Currency risk: risk weight approaches: 0/10 VaR approaches: 10/10.
Security risk: risk weight approaches: 0/10 VaR approaches: 10/10.
Selection of the approach
After calculation of compliance of alternative approaches with the criteria, the score for the model (SM)
is calculated for each of the alternative approaches in the Tables 6-8.
Table 6. Result of comparison of interest rate risk management approaches
Method
A
(max. 17)
B
(max. 22)
C
(max. 21)
SM
D
(max. 23)
E
(max. 17)
Risk weights 0.0 22.0 22.0 0.0 0.0 44.0
VaR 17.0 0.0 0.0 23.0 17.0 57.0
Table 7. Result of comparison of currency risk management approaches
Method
A
(max. 17)
B
(max. 22)
C
(max. 21)
SM
D
(max. 23)
E
(max. 17)
Risk weights 0.0 22.0 22.0 0.0 0.0 44.0
Total
Total
VaR 17.0 0.0 0.0 23.0 17.0 57.0

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Table 8. Result of comparison of security risk management approaches
Method
A
(max. 17)
B
(max. 22)
C
(max. 21)
SM
D
(max. 23)
E
(max. 17)
Risk weight 0.0 22.0 22.0 16.1 0.0 60.1
VaR 17.0 0.0 0.0 6.9 17.0 40.9
As it is seen from the tables, adoption of VaR measures would be appropriate for interest rate and
currency risk management, but for measurement of security risk, risk weight measures would be more
appropriate since the security risk is insignificant for the bank X and likely benefits from VaR measures cannot
outweigh the cost of adoption of these measures.
7. Selection of the models for operational risk management
There are many operational risks, every needs individual management method. That’s why just the
alternative operational risk measurement approaches (Basic Indicator, Standard, Advanced Measurement) will
be studied in this paper.
Compliance of alternative approaches with Criterion A (accuracy of approaches)
Basic indicator approach does not reflect any of bank’s activities; it’s just a ratio time’s gross income.
Standard approach takes into account business lines of bank’s activity but still does not reflect anything with
much accuracy. Rating of approaches according their compliance with criterion A is the following:
Basic indicator approach: 0/10 Standard approach: 2/10 Advanced Measurement approach:
10/10
Compliance of alternative approaches with Criterion B (cost of the adoption)
Using Basic Indicator or Standard approaches would require no additional costs while adoption of
Advanced Measurement approaches would have costs. But Advanced Measurement Approach does not get
minimal score, because some improvements would need to be included in operational risk management system
even without adopting this approach anyway. Rating of approaches according their compliance with criterion
B is the following:
Basic indicator approach: 10/10 Standard approach: 10/10 Advanced Measurement approach:
5/10
Compliance of alternative approaches with Criterion C (cost of using the approach)
It’s similar situation as in compliance with previous criterion. As using Advanced Measurement
approach requires constant reporting, it would be needed to carry out not regarding which measurement
approach is used. Rating of approaches according their compliance with criterion C is the following:
Basic indicator approach: 10/10 Standard approach: 10/10 Advanced Measurement approach:
6/10
Compliance of alternative approaches with Criterion D (reduction of losses when the approach is
applied)
The only approach that has relevance to risk management situation is Advanced Measurement approach.
Basic indicator approach: 0/10 Standard approach: 0/10 Advanced Measurement approach:
10/10
Compliance of alternative approaches with Criterion E (changes in capital charges calculated
using the method)
If the bank is not engaged in very risky activities, Basic Indicator and Standard approaches should result
in higher capital charges. Additionally, when Advanced Measurement approach is applied, bank will be
allowed to recognize the risk mitigating impact of insurance in the measures of operational risk used for
regulatory minimum capital requirements.
Total

VADYBA / MANAGEMENT. 2006 m. Nr. 2(11) 57
Rating of approaches according their compliance with criterion E is the following:
Basic indicator approach: 0/10 Standard approach: 3/10 Advanced Measurement approach:
10/10
After calculation of compliance of alternative approaches with the criteria, the score for the model (SM)
is calculated for each of the alternative approaches in the Table 9.
Table 9. Result of comparison of operational risk management approaches
Approach
A
(max. 17)
B
(max. 22)
C
(max. 21)
SM
D
(max. 23)
E
(max. 17)
Basic Indicator 0.0 22.0 22.0 0.0 0.0 44.0
Standard 3.4 22.0 22.0 0.0 5.1 52.5
Advanced Measurement 17.0 11.0 12.6 23.0 17.0 80.6
As seen from table, adoption of Advanced Measurement approach would be most suitable for
operational risk measurement.
Conclusion
Commercial banks cope with many risks, the most important of which are credit, market, operational and
liquidity risks. As modern banking technologies develop, new risks occur. Statistical risk management
methods, that combined with other management methods give good results, are becoming more popular and
widely used. In order to adapt their risk management systems to Basel II, most commercial banks will have to
make changes in their risk management models. This study showed how paired comparison method could be
adapted to give weights to selected criteria, and how these criteria could be used to improve and adapt risk
management model of the small Lithuanian bank X to the Basel II. It came to the conclusion that adding
statistical VaR based approaches to bank’s X risk management models would help to improve risk
management, but only combined with the classic risk management methods and that if certain risk is not of
significant importance (e.g. security risk for bank X), usage of VaR would not give optimal result as
implementation and usage costs of this model are higher than likely benefits. On the other hand, though
associated with costs, adoption of more advanced risk management methods would give positive results to the
bank through improved accuracy of risk management, reduction of losses from the risk and better allocated
capital.
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Framework. Updated November 2005 // http://www.bis.org
4. Bessis J. Risk Management in Banking. - London, John Wiley & Sons, 1999;
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Total