Quantification of Operational Risk: A Scenario-Based Approach

In this article, I identify challenges to the loss distribution approach in modeling operational risk. I propose a scenario-based methodology for operational risk assessment, which recognizes that each risk can occur under a number of wide-ranging scenarios and that association between risks may behave differently for different scenarios. The model that is developed internally in the company provides a practical quantitative assessment of risk exposure that reflects a deep understanding of the company and its environment, making the risk calculation more responsive to the actual state, ensuring that the company is attending to its key operational risks. In this model qualitative and quantitative approaches are combined to build a loss distribution for individual and aggregate operational risk exposure. The model helps to portray the company's internal control systems and aspects of business environment. These features can help the company increase its operational efficiency, reduce loss from undesirable incidents, and maintain the integrity of internal control.