On operational risk in Vietnam commercial banks - A comparison of quantitative approaches

Abstract

Since the establishment of Basel II in 2007, operational risk has been one of the main types of risk within the banking sector. Basel II & III demands a minimum capital reserves for losses associated with operational risk, hence operational risk management in commercial banks has become one of the most concerned matters. However, due to its late emergence, there has not been many researches on this issue in Vietnam, we seek a reliable and effective operational risk management tools for quantifying operational loss. This research concentrates on applying three main approaches specified in Basel II & III, consisting of: (i) Basic Indicator Approach, (ii) Standard Approach, and (iii) Advance Method Approach, to measure operational loss capital requirements of Vietnamese commercial banks. Our research aims at providing a framework for Vietnamese banks to evaluate the pros and cons of the three Basel’s methods for assessing operational loss. Our methodologies allow researchers and risk managers to model operational risk from the simplest to the more complex Basel approaches. We compare the methodologies, by employing an internal set of operational risk data from a hypothetical Vietnamese commercial bank, and then supplement this set with an external operational risk data from 60 commercial banks worldwide. We then calculate the closed form solution, derived from the Basic Indicator Approach and Standard Approach; and proposed two Monte-Carlo simulations (with and without empirical correlation) methodologies for the Advance Method Approach. The findings of this research underline that the maximum operational loss under each approaches are: 694 billion VND, 663 billion VND, 350 billion VND and 592 billion VND for the (i) Basic Indicator Approach, (ii) Standard Approach; (iii) Monte-Carlo simulations with correlation, and (iv) Monte-Carlo simulations without correlation, respectively. The main conclusion drawn from our research is that the Advance Method Approach, particularly the Monte Carlo Loss Distribution Approach with correlation is the most lenient on capital requirements; but at the expense of more investment in time and effort to implement: (i) Monte Carlo simulation, and (ii) constructed and collate sufficient internal operational loss database.