BIS Paper Analyzes Operational and Cyber Risks in Financial Sector

Representing a significant portion of total bank risks, operational risks are second only to credit risks as a source of losses. Thus, measuring and understanding operational risks, including cyber risks, is critical for both banks and public authorities. The paper uses a unique cross-country dataset from ORX, which is a consortium of financial institutions. The sample contains over 700,000 operational loss events from 2002 until the end of 2017 for a group of 74 large banks with headquarters worldwide. The granularity of the dataset allowed the authors to study the evolution of operational risks through time, compute an operational and cyber value-at-risk for financial intermediaries, document the time lag between occurrence, discovery and recognition of losses, and investigate the link between operational losses, macroeconomic conditions, and regulatory characteristics.

The results of the study show that, after a spike following the Great Financial Crisis, operational losses have fallen in recent years. The spike was largely due to losses arising from improper business practices in large banks that were incurred in the run-up to the crisis but recognized only later. Operational value-at-risk can vary substantially across banks—from 6% to 12% of total gross income—depending on the method used. These numbers are consistent with the actual capital requirements, but notably smaller than the basic indicator approach. The results provide some support for the shift to the standardized approach in Basel III.

The analysis shows that it takes, on average, more than a year for operational losses to be discovered and recognized in the books. However, there is significant variation across regions and event types. For instance, improper business practices and internal fraud events take longer to be discovered. Operational losses are not independent of macroeconomic conditions and regulatory characteristics. The paper shows that credit booms and periods of excessively accommodative monetary policy are followed by larger operational losses. Furthermore, it is to be noted that a higher quality of financial regulation and supervision is also associated with lower cyber losses. Despite representing a relatively minor share of operational losses, cyber losses can account for up to a third of total operational value-at-risk.

Related Links

• Notification
• Working Paper (PDF)

Keywords: International, Banking, Operational Risk, Value-at-Risk, Cyber Risk, Standardized Approach, Research, BIS