Macroenvironmental determinants of operational loss severity

We investigate the relationships between the severity of operational loss events reported in the banking sector and various regulatory, legal, geographical, and economic indicators. Based on a data sample of over 57,000 losses incurred in more than 130 countries reported by the Operational Riskdata eXchange (ORX) consortium, we identify the most relevant exposure indicators for losses in four Basel II event categories: Internal Fraud; External Fraud; Employment Practices and Workplace Safety; and Clients, Products and Business Practices. We find evidence of significant correlations between Internal Fraud and constraints on executive power and the prevalence of insider trading. Clients, Products and Business Practices losses are significantly related to securities and shareholder protection laws, restrictions on banking activity, supervisory power, and the prevalence of insider trading. Other event types are sensitive to per-capita GDP and a governance index.

► We studied how operational loss sizes are affected by macroenvironmental factors. ► The severity of loss types are affected by differences in region and regulation. ► Frauds were correlated with insider trading, executive constraints, and rule of law. ► Legal losses were affected by measures of shareholder and supervisor power. ► GDP per capita and restrictions on real estate activity were also significant.