Key motifs in the home-host mantra of operational risk management

Andy Yeh

Journal of Operational Risk

Abstract: ABSTRACT This paper discusses the key policy issues around Basel II advanced measurement approach implementation. These issues pertain to operational risk governance, capital measurement and allocation, and future advances in operational risk transfer. Although we assess these issues from a host supervisor's perspective, the main themes have practical implications in a broader home-host context. In terms of operational risk governance in the host regime, the local board and senior management must take an activeinterest in operational risk management. A number of workstreams such as scenario analysis, business continuity planning, and audit or other forms of independent assurance could help maintain and reinforce this active interest. Also, the significant subsidiary of a globally active bank is expected to hold an adequate amount of capital for operational risk. At the more disaggregated level, capital allocation must create sound incentives for business lines to carry out effective operational risk management processes. This allocation calls for the integration of the operational risk management processes into the business-as-usual teams. Further, it is important to create a robust link between managerial pay and operational risk-adjusted return. This link helps strengthen the incentives for business lines to enhance operational risk management over time. Future work could shed light on the treatment of diversification benefits between operational risk and other risks as part of the Pillar II supervisory review process. Also, future developments should help promote operational risk transfer via insurance or derivatives. These risk products could help advance the evolution of operational risk management to a new era.

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