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CMA Final · Risk Management in Banking and Insurance · Operational Risk and Off-Balance Sheet Risk

Which statement best describes the Loss Distribution Approach to measuring operational risk capital?

The Loss Distribution Approach combines frequency and severity distributions of operational losses to estimate an aggregate loss at a high confidence percentile. Fixed percentages of gross income are features of the Basic Indicator and Standardised approaches, not this internal-model method.

  1. AIt applies a fixed percentage to average gross income
  2. BIt combines frequency and severity distributions of losses to estimate a high-percentile aggregate lossCorrect
  3. CIt assigns a fixed beta to each business line
  4. DIt uses the bank's net interest margin as a risk proxy

Explanation

The Loss Distribution Approach, an advanced measurement technique, models how often loss events occur and how large each is, then aggregates them to a high confidence level such as 99.9%. Fixed percentages of income describe the Basic Indicator and Standardised approaches.

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