Scenario analysis probably represents the best way of validating the capital calculations for operational risk as it is an elegant way of applying expert judgment on top of a statistical model.
To begin with, an organisation determines which scenarios are appropriate and what the extent of loss for each scenario would be. There are various ways of determining this. The recent paper by the Basel Committee on the range of practices amongst AMA banks (issued July 2009) indicates that the most popular way of determining the appropriate scenarios and the losses in those scenarios is by holding workshops involving multiple employees or business units (90% of respondents responded this as their preferred method).
Optial’s Scenario Templates are used to define such possible risk scenarios in a workshop environment, determine the possible impact, probability and costs associated with a risk event and the associated mitigation techniques. This information is then available for stress testing and modelling capital allocation using the Optial quantitative modelling tool.
In Optial, Scenario Templates can be created and set in libraries at any level within the organisation hierarchy. They have their own workflow process which is based on Scenario discussion and definition in a workshop environment.
The Template stores data about the Scenario such as description, status, summary of key decision points from the workshop and mitigation techniques. Qualitative assessments can be made based on best and worst case scenarios using on impact/probability ratings and annual probability percentages. Financial impact assessments can also be made in terms of expected loss amounts in best and worst cases and also the amount of capital that should be allocated against this risk Scenario.
In all cases justification text is required to support the assessments which are then driven to acceptance and sign-off via the Optial workflow engine.
As with all objects in the Optial system, Scenario Templates can be linked to any other item in the system, e.g. existing risks, loss events, actions, findings, etc. to provide management with a complete picture of the scenario.