Comparison To Operational Risk Considerations in The Context of Banks' Prudential Capital Requiremen
Much of the literature associated with ODD, particularly the academic literature, is based on an underlying definition of operational risk that was originally designed in the context of the banking industry and contained within the Basel Accords, which holds that operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.
The banking industry is, in most economies, subject to regulation by a national financial services supervisory body, for example the Financial Services Authority in the UK, with the regulatory regime including a requirement for banks to hold at least minimum levels of capital designed to withstand the likely incidence of various risks, including operational risks. The capital held by banks for the purpose of meeting the requirements of the relevant regulator(s) is referred to as their capital requirement or prudential capital.
The imperative of considering operational risk in the context of banks is to ascertain an amount in currency which, if maintained by the bank as capital, should (in theory at least) fully compensate for the expected impact of crystallisation of the operational risks faced by the bank. When this “operational risk requirement” is added to the other elements of a bank’s prudential capital requirement (relating to non-operational risks faced by the bank), the resulting total gives the bank’s “total capital requirement”.
Read more about this topic: Operational Due Diligence (alternative Investments)
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