Aggregation with market & credit risk

For many parts of an organisation there may be no market or credit risk - for these areas, such as sales, manufacturing, retail counter banking and telephone call centres, operational and business risk covers all of their risks.

But at the Group level the operational and business risk measure needs to be integrated with market and credit risk to establish an overall measure of risk being run by the organisation. Particularly for banks, this is the figure that the regulators and rating agencies should be interested in, and the bank's capital buffer should cover.

And it is this combined risk capital measure that needs to be apportioned out to the various businesses or segments to form the basis for risk adjusted performance measures.

It is not sufficient just to add the operational, credit and market risks together. This would overcount the risk - the risk domains are by no means perfectly correlated, which a simple addition would imply. A sharp hit in one risk domain does not imply equally sharp hits in the others.

Yet they are not independent either. A sharp economic downturn will affect credit and many operational risks and probably a number of market risks as well.

The combination of these domains can be handled in a similar way to correlations within operational risk, provided aggregate risk distributions and correlation factors can be estimated for both credit and market risk.

To Distributing diversification benefits

Last updated:16/5/07

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