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    Prasad Kodali

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    jtnylson
    The document discusses operational risk management and measurement at a financial institution. It covers operational risk roles, measurement philosophy and methodology, and the assessment process. The key points are: 1) Operational risk management involves both a firm-wide department that sets policies and a business line risk management that executes assessments and reports losses. 2) The measurement model uses internal loss data and scenario analysis as inputs, with a conservative methodology applying maximum correlations and no overrides. 3) Scenario analysis involves validating risks, estimating frequencies by severity buckets, and is conducted at the lowest business unit level quarterly or if risks change.

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    Prasad Kodali

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    jtnylson
    95 views9 pages
    The document discusses operational risk management and measurement at a financial institution. It covers operational risk roles, measurement philosophy and methodology, and the assessment process. The key points are: 1) Operational risk management involves both a firm-wide department that sets policies and a business line risk management that executes assessments and reports losses. 2) The measurement model uses internal loss data and scenario analysis as inputs, with a conservative methodology applying maximum correlations and no overrides. 3) Scenario analysis involves validating risks, estimating frequencies by severity buckets, and is conducted at the lowest business unit level quarterly or if risks change.

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    The document discusses operational risk management and measurement at a financial institution. It covers operational risk roles, measurement philosophy and methodology, and the assessment process. The key points are: 1) Operational risk management involves both a firm-wide department that sets policies and a business line risk management that executes assessments and reports losses. 2) The measurement model uses internal loss data and scenario analysis as inputs, with a conservative methodology applying maximum correlations and no overrides. 3) Scenario analysis involves validating risks, estimating frequencies by severity buckets, and is conducted at the lowest business unit level quarterly or if risks change.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Flag for inappropriate content
    Download as pdf or txt
    95 views9 pages

    Prasad Kodali

    Uploaded by

    jtnylson
    The document discusses operational risk management and measurement at a financial institution. It covers operational risk roles, measurement philosophy and methodology, and the assessment process. The key points are: 1) Operational risk management involves both a firm-wide department that sets policies and a business line risk management that executes assessments and reports losses. 2) The measurement model uses internal loss data and scenario analysis as inputs, with a conservative methodology applying maximum correlations and no overrides. 3) Scenario analysis involves validating risks, estimating frequencies by severity buckets, and is conducted at the lowest business unit level quarterly or if risks change.

    Copyright:

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    of 9

    Operational Risk Management and Measurement

    May y 2010

    Agenda

    Operational Risk Roles Measurement Philosophy Model inputs Model Methodology

    Assessment Evolution of Scenario Analysis Process Granularity of Scenario y Analysis

    Client and Regulatory focus

    Operational Risk Roles


    Firm Operational Risk Department

    Sets Operational Risk policies and procedures Creates standards for assessments Maintains systems and standards for loss data collection Calculate Capital Report to Board and management committees Manage regulatory communication

    Business Line Risk Management


    Manage day to day risk Report loss events Execute assessment programs (RCSA, SA etc. )

    Measurement Philosophy
    Model on basis of relevant, quantitative data where available and reliable Scenario Analysis (SA) data is used:

    as a proxy for external data as a means of addressing insufficient loss data to introduce forward-looking elements into the model to assist in the management of Operational Risk

    Conservative judgments are made according to the quality of the data (e.g.
    maximum correlation calculated is used)

    No overrides are made to model inputs No qualitative adjustments are made post Monte Carlo simulation Transparent and Easy to explain

    Measurement Inputs
    Internal Loss Data A direct input into the model Direct losses > $20k are used to model both the loss frequency and loss severity distributions. E t External l Loss L Data D t An indirect input into the model A key input to the Scenario Analysis process, it provides participants with potential OR exposures relevant to the Firm. Also used to determine correlations between risk types and benchmarking. y Scenario Analysis A direct input into the model Used to model the severity distribution. Allows prospective changes to the risk profile to be reflected in the AMA model. Addresses data paucity in the tail of some risk type yp severity y distributions. RCSAs An indirect input into the model Used to identify and assess inherent risk, residual risk, control performance and appropriateness of mitigating actions. RCSAs trigger and inform the Scenario Analysis process.

    Measurement Methodology
    Model Inputs Model Processes Model Outputs

    Frequency of Internal Loss Data Frequency

    Internal Loss Data (>20K)


    Weight x1
    Severity-ID

    Monte Carlo Simulation

    Aggregate Loss Distribution (ALD)

    AMA Capital Economic Capital


    Scenario Analysis (>$10MM) Business Judgment RCSA Internal Data External Data Audit/ SOX Weight (1-x)1

    Severity-SA2

    Severity

    Above process is performed for each unit of measure Capital is aggregated using a Gaussian copula A conservative estimate of correlation between Risk Event Categories is used based on empirical research Multiple model runs are executed in a structured process to reduce simulation variance
    1The

    BEICFs

    Management Focus Items

    weights of ILD and SA data are derived using a scorecard approach for each unit of measure Simulation found to be conservative and stable relative to fitted severity distributions for SA data.

    2Empirical

    Assessment Evolution of Scenario Analysis


    Various methodologies for collecting estimates were considered :

    Granularity: Individual scenario, risk event type Structure of estimates: synthetic point, percentiles, frequencies by severity buckets and probabilities by severity buckets

    Criteria used to evaluate these methods:


    Effectiveness in capturing changes in risks by engaging Biz units Stability and sensitivity of capital to changes in estimates Ability to aggregate estimates Acknowledge and leverage the consensus based decision making culture of Morgan St l Stanley

    Collection of frequency estimates by standardized severity bucket at the Risk Event type level for each business unit was chosen and implemented starting 2006 Q4

    Assessment Process
    RCSAs are refreshed every quarter for all business units ORD and BU work together g to validated existing g risks and identify y any y new risks Triggers for Scenario Analysis re-assessment:

    Change in RCSA risks or scores External Events Change in Business environment SA scores are stale, meaning they have not been re-assessed for more than 6 quarters
    Operational Risk Event Annual Frequency by Severity Bucket
    1 2 3 4 5 6 Total Freq. Upper Bound

    $10M - $20M # Events # Years Frequency q y 1 5

    $20M - $50M 1 15

    $50M - $100M 1 20

    $100M - $250M 0 0

    $250-$1B 0 0

    $1B+ 0 0

    3. The last step is to estimate the frequency within each severity bucket

    $ 100,000,000

    0.20

    0.07

    0.05

    0.00

    0.00

    0.00

    0.32

    2.
    Rank

    Rank Scenarios with respect to potential severity of loss.

    Scenario

    1 2 3 4

    Theft of intellectual/physical property Theft of confidential information (both MS and client) Fraudulent trading (Misrepresentation by counterparty, Forgery))

    3 2 1

    1. The first step is to


    validate Scenarios that could lead to a large loss.

    Assessment Scenario Analysis Granularity


    Morgan Stanley y BCM/CS HR

    Sales and Trading

    Investment Banking

    Wealth Management

    Investment Management

    Equities

    Fixed Income

    M&A

    GCM

    Core

    MB/PE

    Ex-Commodities
    Note:

    Commodities

    Orange boxes represent lowest level of modeling unit as well as lowest level at which scenario analysis was held HR & BCM workshops k h are conducted d t d on th the fi firm wide id l level, l BCM/CS: Business Continuity Management and Corporate Services

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