QF 603 Quantitative Analysis of Financial Markets

Operational Risk Management using Time Series Analysis

An attempt to understand Banking Operational Losses better and Quantify it by relating it to Macroeconomic data

Team Members (Group 7)

Bram Prawira GANI (01456815)

Eugene LIM Joon Kiat (01241520)

GOH Boon Chin (01452072)

Gourav Kumar AGARWAL (01471643)

TOH Huiting (01473581)

MQF 2023 1
 OUR ROADMAP
DATA CONCLUSION
PROJECT PROCESSING & (ECONOMIC
Q&A
OBJECTIVES ANALYSIS SIGNIFICANCE)
4 6 8
2

INTRODUCTION
1

3 5 7

QF603
OVERVIEW OF MODELS FITTING LESSONS LEARNT,
METHODOLOGY & FUTURE IMPROVEMENTS,
RESULTS

2
INTRODUCTION

3
 What is Operational Risk?

Operational Risk is defined as “… the risk of direct or indirect loss resulting from
inadequate or failed internal processes, people and systems or from external events”.

4
 Due to Un-
authorized
Trading

(Source: https://ethicsunwrapped.utexas.edu/)
5
Source:
1. https ://www.investopedia.com/)
2. https ://www.britannica.com/event/Enron-scandal
6
(Source: https://archive.nytimes.com/)
7
Source:
1. https ://channelnewsasia.com
2. https ://www.mas.gov.sg/ 8
Top 10 Operational Risks in Y2023 & Likelihood of Occurring

(Source: https://www.riskcompliance.biz/)
9
PROJECT OBJECTIVES

10
 Motivation
• ~250+ bn Euros have been lost in last 20 years by Banks as Operational losses
Region Gross Operational Loss Percentage
Europe & UK 12,425,069,685 63.66%
North America 4,262,678,242 21.84%
Asia/Pacific 2,620,357,530 13.43%
Africa 208,473,359 1.07%
Average Annual Operational Losses by Region

• The main problem statement is how do we create an estimate for these Operational losses in the
future so we can Risk manage them.

• The relationship between market/economy and Credit/Market risk is well defined. While
the relationship for Ops Risk are not well defined, less deterministic and qualitative in nature
with no sensitivity to market/economic factors

• Lack of quality internal loss data, broad nature of Ops risk losses, difficulty in observing and
measuring drivers are some other challenges.

• We conducted an exploratory research analysis to understand operational risk better and

deduce some possible relations.
11
 Project Objectives

Questions we are looking to answer?

• Can we forecast External Operational risk losses using Aggregate External loss history ?

• Can we also establishing a relationship with Market/Economic factors so to make it sensitive to

Risk factors?

• Can we find a relation between Internal Operational losses and External Operational losses so to
complement the lack of good quality Internal data with External losses?

• How do we account for Operational risk tail risk?

Potential Use Cases

• For Banks – A better Risk management and Business continuity

• For Regulators – Define better Capital Requirements to minimize Market impact

• For Market – Stability and Investor's confidence

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OVERVIEW OF
METHODOLOGY

13
 DATA PROCESSING METHODOLOGY

Data Model Data Result

Processing& Model Fitting
Collection Selection Analysis Interpretation

Time series analysis

and decomposition

Multi-colinearlity

Significance of
independent
variables to
dependant variables

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 OLS Lasso

ARIMAX Machine Ridge

Learning

Model KNN
Selection
CART
VAR/VECM PCA

LSTM
GARCH

15
Macroeconomic Variable Selection Process

Multivariate
Macroeconomic Check Regression to
Variables Correlation/VIF
check overall
Selection for Collinearity significance

Use the final

Univariate shortlisted
Outlier Regression as
Smoothening variable for
2nd filter modelling

Data Check
Transformation Stationarity as
(Diff/Logs/Lag) 1st filter

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 Exogenous Variables Considered
List of Macroeconomic Variables considered Variable Transformation of Macro-economic variable
Europe & UK Asia Pacific Level Lag 1
UK unemployment Rate CPI East Asia Lag2
UK 10 yr bond yield CPI Southeast Asia Lag 3
Nominal GDP UK Hong Kong Unemployment Lag 4
Real GDP UK Singapore GDP First Difference Lag 1
UK equity price Hong Kong Property Prices Lag2
Euro GDP percapita China GDP Lag 3
Euro Labour productivity Lag 4
Euro 10yr bond yield Second Difference Lag 1
CPI UK Lag2
Euro Output Gap Lag 3
Euro Unemployment Lag 4
GBPUSDFX Rate Log Difference Lag 1
Bank Conc Lag2
Lonterm Interest Rate Lag 3
UK House Index Lag 4
Deposit Rate Quarter over Quarter Lag 1
Marginal lending Rate Lag2
Refinancing Rate Lag 3
Lag 4
Segmentation of External Loss Data
• Operational losses have different risk drivers - can vary by Business Segment & Geography

Region External Gross Operational Loss Percentage Business Segment Gross Operational Losses Amount Percentage
Europe & UK 12,425,069,685 63.66% Commercial Banking 11,464,424,770 58.74%
North America 4,262,678,242 21.84% Retail Banking 6,101,724,929 31.26%
Asia/Pacific 2,620,357,530 13.43% Private Banking 638,814,587 3.27%
Africa 208,473,359 1.07% Rest of the Business 1,311,614,530 6.72%
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MODELS FITTING & RESULTS

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 Variables selection for EUR / ASIA
Europe Asia
• Correlation test (gauge)

Multi-colinearity check

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Europe & UK Commercial Segment

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 EUR Commercial Plot (Train set till Dec 2013)
Before difference After difference

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ARIMA (Euro-Commercial)

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 ARIMA X_EUR_Commercial (2,0,1)

Ljung Box Test:

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OLS for EUR Econ Using correlation test

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VAR Order1 and VECM EUR Commerical Order 1

Variables
• Euro_outputgap
• Unemplyment_EURO
• longterm_interest
• UK_house_index

Johansen Cointegration test r

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Using Machine Learning on same OLS selected variables

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Summary Results (Euro-Commercial)

Based on RMSE and the plot trend, LASSO and

ARIMAX performed the best forecast.

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Europe & UK Retail Segment

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 Euro & UK Retail Banking Operational Losses

External Operational Loss timeseries

External Operational Loss timeseries after BoxCox 1st Diffrence

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 Euro & UK Retail Banking – Operational Loss ACF & PACF

Looking at the ACF & PACF, an ARIMA(0,0,1) could be a good fit since ACF cuts off after
lag 1 and PACF seems to tail off.

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 Euro & UK Retail Banking – Exogenous Variable Stationarity Check

Ndiffs/KPSS Test result for Transformed Variables

Sum of ndiffs Transformation
Level D1 D2 LogD1 QoQ
Attributes L0 L1 L2 L3 L4 L0 L1 L2 L3 L4 L0 L1 L2 L3 L4 L0 L1 L2 L3 L4 L0 L1 L2 L3 L4
Bankconc 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
CPIUK 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1
depositrate 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
EMPUKQ 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 0 0 0 0
euroCreditGDP 1 1 1 1 2 0 0 0 0 1 0 0 0 0 0 1 1 0 0 1 1 1 1 1 1
eurogdppercapita 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
euroLabourproductivity 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
Eurooutputgap 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
Europe.and.UK.Commer
cial.Banking 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
Europe.and.UK.Retail.Ba
nking 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
euryield 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
FX 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
GBMT10UK 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
longterminterest 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 1 0 0 0 0 0 0
marginallending 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 0 0 0 0 0
NGDPMPUKQ 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
refinacning.rate 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 0 0 0 0 0
RGDPMRPUKQ 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
SPPUKQ 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
UKhouseindex 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 0 0 0 0
UnemplymentEURO 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1

*Numbers above indicates order of integration. 0 means stationary

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 Euro & UK Retail Banking - Uni Variate OLS to filter Exogenous
Variables
Adj R-square each variable:

Adj R2 Column Labels

Level D1 D2 LogD1 QoQ
Row Labels L0 L1 L2 L3 L4 L0 L1 L2 L3 L4 L0 L1 L2 L3 L4 L0 L1 L2 L3 L4 L0 L1 L2 L3 L4
Bankconc -0.0189 -0.0187 -0.0189 -0.0196 -0.0190 -0.0178 -0.0181 -0.0172 -0.0050 -0.0199 -0.0132 -0.0193 0.0196 -0.0064 -0.0205 -0.0185 -0.0155 -0.0186 -0.0039 -0.0203 -0.0193 -0.0200 -0.0189 -0.0143 -0.0212
CPIUK -0.0189 -0.0189 -0.0191 -0.0194 -0.0182 -0.0153 -0.0175 -0.0188 -0.0122 0.0118 -0.0186 -0.0135 0.0040 -0.0155 0.1696 -0.0166 -0.0172 -0.0187 -0.0118 0.0112 -0.0189 -0.0116 -0.0208 -0.0174 -0.0207
depositrate -0.0157 -0.0170 -0.0192 -0.0188 -0.0175 -0.0168 0.0160 -0.0097 0.0240 0.0387 0.0042 0.0773 -0.0081 0.2194 -0.0162 0.0084 -0.0225 -0.0071 -0.0245 0.0054 -0.0194 -0.0188 -0.0194 -0.0153 -0.0061
EMPUKQ -0.0165 -0.0182 -0.0189 -0.0190 -0.0118 0.0161 -0.0189 -0.0140 -0.0120 -0.0159 0.0108 -0.0175 0.0051 -0.0191 -0.0133 0.0175 -0.0185 -0.0147 -0.0127 -0.0159 -0.0166 -0.0194 -0.0208 -0.0132 -0.0161
euroCreditGDP -0.0188 -0.0180 -0.0187 -0.0189 -0.0193 0.0260 0.0198 -0.0194 -0.0119 -0.0201 0.0630 0.0017 -0.0175 -0.0137 -0.0150 0.0295 0.0209 -0.0189 -0.0139 -0.0202 -0.0162 -0.0178 -0.0206 -0.0191 -0.0190
eurogdppercapita 0.0088 -0.0164 -0.0187 -0.0024 0.0278 0.2157 0.0182 0.0871 0.3415 0.2165 0.1187 0.0596 0.2266 0.3253 0.1132 0.2076 0.0148 0.0842 0.3370 0.2048 -0.0198 -0.0185 -0.0201 -0.0174 -0.0130
euroLabourproductivit
y -0.0185 -0.0182 -0.0191 -0.0191 -0.0089 -0.0172 -0.0042 -0.0178 0.0534 -0.0147 0.0074 -0.0130 0.0729 0.1007 -0.0141 -0.0172 -0.0034 -0.0178 0.0583 -0.0143 -0.0161 -0.0203 -0.0208 -0.0210 -0.0133
Eurooutputgap -0.0183 -0.0167 -0.0180 -0.0180 -0.0198 -0.0093 -0.0136 -0.0195 -0.0112 -0.0105 0.0413 -0.0048 -0.0033 -0.0201 -0.0207 -0.0618 -0.0591 -0.0477 0.0368 -0.0571 -0.0191 -0.0142 -0.0133 -0.0114 -0.0162
Europe.and.UK.Comm
ercial.Banking -0.0086 0.0116 -0.0192 -0.0161 -0.0110 0.0665 0.0161 -0.0162 -0.0016 0.0331 0.0714 0.0047 -0.0032 0.0368 0.0790 0.0733 -0.0148 0.0000 -0.0166 0.0639 -0.0190 -0.0189 -0.0145 -0.0173 -0.0217
Europe.and.UK.Retail.
Banking 0.3039 0.2563 -0.0188 -0.0189 0.0328 0.6741 0.1594 -0.0183 0.0102 0.1230 0.5092 0.0502 -0.0051 0.0821 0.1076 1.0000 0.2366 -0.0144 -0.0172 0.0973 0.1166 0.0372 -0.0208 -0.0185 -0.0207
euryield -0.0183 -0.0169 -0.0162 -0.0195 -0.0200 -0.0125 -0.0192 0.0519 0.0430 -0.0157 -0.0144 0.0455 0.2043 0.0040 0.0821 -0.0202 -0.0082 -0.0160 -0.0180 -0.0227 -0.0200 -0.0197 -0.0155 -0.0202 -0.0107
FX -0.0162 -0.0157 -0.0192 -0.0159 -0.0168 -0.0187 -0.0066 -0.0024 -0.0005 0.0069 -0.0069 -0.0193 0.0370 -0.0195 0.0646 -0.0182 -0.0004 -0.0021 0.0105 0.0004 -0.0198 -0.0198 -0.0208 -0.0210 -0.0217
GBMT10UK -0.0179 -0.0176 -0.0161 -0.0192 -0.0167 0.0415 -0.0178 0.0527 -0.0191 0.0299 0.0076 0.0410 0.0313 0.0104 0.0500 0.0266 -0.0183 0.0335 -0.0200 0.0306 -0.0200 -0.0204 -0.0190 -0.0211 -0.0217
longterminterest -0.0170 -0.0188 -0.0181 -0.0128 -0.0010 -0.0039 -0.0067 0.1240 -0.0135 0.0243 -0.0192 0.1479 0.1170 -0.0041 0.0384 -0.0042 -0.0127 0.0955 -0.0060 0.0246 -0.0172 -0.0204 -0.0175 -0.0190 -0.0199
marginallending -0.0177 -0.0187 -0.0190 -0.0195 -0.0199 -0.0081 -0.0184 -0.0189 -0.0131 -0.0186 -0.0120 -0.0196 -0.0076 -0.0189 0.1373 0.0182 -0.0185 -0.0187 -0.0200 -0.0196 -0.0194 -0.0197 -0.0152 -0.0177 -0.0124
NGDPMPUKQ -0.0188 -0.0187 -0.0192 -0.0196 -0.0156 -0.0032 -0.0184 -0.0194 -0.0186 -0.0121 -0.0029 -0.0195 -0.0198 -0.0088 0.0013 -0.0039 -0.0171 -0.0196 -0.0198 -0.0149 -0.0193 -0.0204 -0.0204 -0.0209 -0.0165
refinacning.rate -0.0171 -0.0182 -0.0192 -0.0192 -0.0197 -0.0139 -0.0058 -0.0179 0.0042 -0.0082 -0.0164 0.0169 -0.0038 0.0814 0.0127 -0.0045 -0.0192 -0.0149 -0.0184 -0.0202 -0.0200 -0.0204 -0.0175 -0.0159 -0.0088
RGDPMRPUKQ -0.0187 -0.0159 -0.0156 -0.0173 -0.0155 -0.0110 -0.0192 0.0012 -0.0195 0.0241 -0.0165 -0.0098 -0.0151 0.0070 0.0031 -0.0138 -0.0145 -0.0240 -0.0166 -0.0084 -0.0195 -0.0199 -0.0207 -0.0134 -0.0145
SPPUKQ -0.0186 -0.0188 -0.0123 -0.0185 -0.0192 -0.0127 0.0659 0.0046 -0.0124 0.0241 0.0795 0.1272 -0.0136 0.0408 0.0364 -0.0131 0.0495 0.0122 -0.0188 0.0282 -0.0156 -0.0091 -0.0205 -0.0203 -0.0217
UKhouseindex -0.0177 -0.0155 -0.0191 -0.0196 -0.0131 0.0108 0.0560 -0.0193 -0.0200 0.0430 0.2044 0.0601 -0.0198 0.0666 0.2713 0.0122 0.0665 -0.0195 -0.0182 0.0363 -0.0197 -0.0200 -0.0207 -0.0164 -0.0177
UnemplymentEURO -0.0182 -0.0182 -0.0190 -0.0194 -0.0191 -0.0189 -0.0034 -0.0192 -0.0125 -0.0028 0.0280 0.0138 -0.0089 -0.0152 -0.0174 -0.0189 -0.0038 -0.0195 -0.0158 0.0030 -0.0152 -0.0092 -0.0116 -0.0118 -0.0159

*Top 10 variables w ith highest Adj R-Square is highlighted in Green

32
 Model Selection

➢ Based on the Univariate regression (|Adj R-square| > 0.3) and looking at Correlation matrix,
we get the below short listed exogenous variables:

• eurogdppercapita_D1_L3 i.e. EuroGDP per Capita First difference Lag 3

• eurogdppercapita_D2_L3 i.e. EuroGDP per Capita Second difference Lag 3
• eurogdppercapita_LogD1_L3 i.e. EuroGDP per Capita Log Return Lag 3
• ukhouseindexD2_L4 i.e. UK House Index Second difference Lag 4

➢ Since, 3 of the above variables are transformation of EuroGDP per capita, we will only use
one of them.

➢ Next, We ran a Multivariate OLS to see which of these variables were most significant in
explaining the dependent variable

➢ Finally, we will run ARIMA-X on the selected variables to build our model

33
 Multivariate OLS Result

As can be seen, over all the Regression

was significant with 0.0014 p-value for F-
Statistic.

Final selected exogenous variables:

• Log return of Euro GDP per Capita

from 3 quarters before. Selected
because other Euro GDP terms had
close to zero co-efficient.

• 2nd difference of Euro GDP per

Capita from 4 Quarters before

34
ARIMAX Model
ARIMA (0,0,1) on the 1st difference of BoxCox transformed Losses seems the best
model. Below are the ARIMAX and Ljung-Box results for ARIMA (0,0,1):

AICs, BIC and residual Ljung-Box p-value comparison across other models considered:

Model AICc BIC Ljung-Box p-value

ARIMA (0,0,1) -54.17 -48.25 0.744
ARIMA (1,0,1) -51.77 -45.17 0.616
ARIMA(2,0,1) -49.7 -42.62 0.5459

35
Actual vs Predicted Europe & UK Retail Losses

36
Asia Retail Segment

37
 Asia Retail Operational Losses – Variable Treatment

• Operational loss variable requires 1 non-seasonal difference.

• KPSS: Unable to reject the null hypothesis of stationarity as test statistic is lower than all critical values.

• ADF: Reject the null hypothesis of the data having a unit root.

38
 Asia Retail Operational Losses – Variable Treatment (Continued)

• Time series plots for our operational loss at 1st difference with BoxCox.

• Variable range is relatively constant.

• Gradual decay of the PACF which is indicative of a MA(1) process.

39
Asia Retail Operational Losses – Univariate OLS Results

• Result above are using 1st diff of BoxCox transformed Independent and dependent variable

• Coefficient here is statistically significant.

• Adjusted R-squared and p-value are also more favorable than the multivariate OLS in the
appendix.

40
Asia Retail Operational Losses – ARIMA-X Performance
• Carry out univariate OLS to determine which form of independent variables would give us
the highest adjusted R-squared.

• Variable that gave us the best result: CPI_SouthAsia_BoxCoxD1_L3.

• ARIMA(0, 0, 1) model with low AICC and BIC.

• Low RMSE but somewhat high MAPE which might mean that the model does not capture outliers
that well.

• P-value of residuals test is larger than significance level, do not reject H0 of no autocorrelation.

41
Asia Retail Operational Losses – Forecast Results

• Prediction is relatively decent for the first part of the series. Only goes awry in the latter half of
2015.

• This is only 1 independent variable being utilised.

42
Internal Operational Losses
vs External gross loss

43
Linking Internal Operational Risk RWA to Ext Losses & other Variables

Plots of Operational Risk RWA from Bloomberg

Barclays Bank PLC UBS Group AG

Linking Internal Operational Risk RWA to Ext Losses & other Variables

Result (Adj R-square) of Univariate Regression

Barclays Bank PLC UBS Group AG

Independent Variables Adj R-square Independent Variables Adj R-Square

eurogdppercapita 0.36366958 UKhouseindex 0.494606831
GBMT10UK 0.24310691 SPPUKQ 0.452553356
euroCreditGDP 0.22175367 NGDPMPUKQ 0.452124002
Europe.and.UK.Retail.Banking 0.20574432 GBMT10UK 0.441406676
UKhouseindex 0.19949977 euroCreditGDP 0.422995575
EMPUKQ 0.19941819 marginallending 0.422335867
NGDPMPUKQ 0.19764008 EMPUKQ 0.372065552
longterminterest 0.19720851 longterminterest 0.33802685
euryield 0.18843008 Eurooutputgap 0.313053349
euroLabourproductivity 0.18594976 depositrate 0.288805782
SPPUKQ 0.18074848 CPIUK 0.288179206
CPIUK 0.17767038 euroLabourproductivity 0.280430351
marginallending 0.16319876 refinacning.rate 0.271698541
UnemplymentEURO 0.11452042 Bankconc 0.240469485
refinacning.rate 0.10106152 UnemplymentEURO 0.23577408
Eurooutputgap 0.03312138 euryield 0.207103732
depositrate 0.02968045 eurogdppercapita 0.204090474
GBPUSDFX 0.00027938
RGDPMRPUKQ 0.154496266
Europe.and.UK.Commercial.Banking -0.0100796
GBPUSDFX -0.022830056
Bankconc -0.0179613
Europe.and.UK.Retail.Banking -0.028740037
RGDPMRPUKQ -0.0303466
Europe.and.UK.Commercial.Banking -0.036621341
45
 Barclays Bank vs UBS Group contrasting Results

In the Previous slide, we observed that:

• Barclays Bank Operational Risk RWA showed dependency on overall

UK/Europe Retail segment operational losses.

• UBS did not show much dependency on the UK/Europe Retails Operational losses.

We think the above observation could be due to:

• We think the above observation could be due to Barclays Bank being a

predominently a Retail Bank while UBS is more on Investment Banking/Wealth
Management side.

• Barclays being predominently in UK and UBS in Europe could be another line of

reasoning.

In Conclusion, We will have to extend this research analysis to all GSIBs (Globally
systematic important banks) to have more information to deduce any reasonable
inference.
46
 Can the Gross external Ops Losses explain Idosyntric/Internal Ops
Losses?

For Barclays Group PLC,

• Taking the top 5 variables which had
the highest univariate Adj R-square,
we ran a Multi variate OLS

• Result on the right

• Overall, the OLS was significant

looking at the F-stat with an Adj R-
square of 0.6709

• Europe & UK External Retail Ops

losses had the lowest p-value of the
t-statistic.
> dw_test <- durbinWatsonTest(rwa_ols)
> print(dw_test)
lag D-W Statistic p-value
1 1.867572 0.634

47
CONCLUSION (ECONOMIC
SIGNIFICANCE)

48
 Conclusion & Economic Significance
• Overall, we managed to get good prediction for Operational losses using multiple models

• We prefer OLS/ARIMAX as it help us discover the relationship between Independent and dependent
variable which fits our exploration purpose to find dependencies with sensitivities

Euro/UK Commercial ARIMAX

Euro/UK Commercial OLS

Euro/UK Retail ARIMAX

• A common observation was that gdp with negative co-efficient and interest/yield with a positive co-efficient appeared
on multiple occasions which may indicate a strong relationship of them as lagging indicators

• Inverse relation to GDP could indicate that cost cutting/less revenue during recessionary periods may lead to cutting
corners hence increasing the Operational losses.

49
 Conclusion & Economic Significance

• Positive relation to Interest rate could indicate similar cutting corners when Capital costs are high and
overall economy is adding more risk premium.

• Positive relation to house index could be linked to inflation.

• Inverse relation to unemployment is tough to explain. No Causation?

• We also found that in some cases Internal losses (proxied by Operation Risk RWA) could be explained
by External loss data. More Banks needs to be considered to understand any pattern.

How this results can be used?

• The relationships modelled can be used to forecast Operational losses and Quantify Operational Risk

• The modelled sensitivities can be used to understand the impact of a potential stress period on Ops Losses

• In cases, where a strong relationship between Internal and External losses were found, External data which is
more easily available can be used to supplement the rather patchy Internal data.
LESSONS LEARNT, FUTURE
IMPROVEMENTS
 Challenges/Future Improvements

Challenges
• Data was limited, patchy and tough to find
• Limited number of macroeconomic variables may have restricted the model
• A very steep learning curve for us in a very short time

Future Improvements
• Extend our research on other Business Segments/Geographies to gain more insight
• Extend Internal vs Aggregated loss analysis to all GSIBs to check if there is a pattern
• Source more data to get better results
• Add the effect of tail risk
• Further fine tune codes for better model performance

Our R code is on github and is available at https://github.com/agarwgou/qafmproject

52
Q&A

53
THANK YOU!

54
OLS for EUR Econ Using PCA components
• OLS Regression Results
• ==============================================================================
• Dep. Variable: Commercial_Banking R-squared: 0.209
• Model: OLS Adj. R-squared: 0.036
• Method: Least Squares F-statistic: 1.207
• Date: Tue, 31 Oct 2023 Prob (F-statistic): 0.327
• Time: 07:32:23 Log-Likelihood: -317.75
• No. Observations: 40 AIC: 651.5
• Df Residuals: 32 BIC: 665.0
• Df Model: 7
• Covariance Type: nonrobust
• ==============================================================================
• coef std err t P>|t| [0.025 0.975]
• ------------------------------------------------------------------------------
• const 46.6638 127.073 0.367 0.716 -212.175 305.502
• 0 -1465.8462 961.959 -1.524 0.137 -3425.292 493.599
• 2 -49.8971 105.602 -0.473 0.640 -265.002 165.208
• 3 -129.0449 279.888 -0.461 0.648 -699.158 441.068
• 5 104.1501 181.286 0.575 0.570 -265.118 473.418
• 6 -214.8707 325.688 -0.660 0.514 -878.276 448.535
• 7 4.3375 4.478 0.969 0.340 -4.783 13.458
• 9 882.9905 730.092 1.209 0.235 -604.158 2370.139
• ==============================================================================
• Omnibus: 15.083 Durbin-Watson: 2.407
• Prob(Omnibus): 0.001 Jarque-Bera (JB): 32.021
• Skew: 0.802 Prob(JB): 1.11e-07
• Kurtosis: 7.079 Cond. No. 302.
• ==============================================================================

•• Notes:
[1] Standard Errors assume that the covariance matrix of the errors is correctly specified. 55
Features Extraction for EUR Commercial

• PCA

56
APPENDIX & REFERENCES
Goldfeld-Quandt Test for UK Retail OLS

• As can be seen, we fail to reject the Goldfeld-Quandt test which means the
errors have constant variance i.e. homoscedasticity

• This is a condition for OLS to hold

58
Breusch-Pagan Test for UK Retail OLS

• As can be seen, we fail to reject the Breusch Pagan test which means the
errors have constant variance i.e. homoscedasticity

• This is a condition for OLS to hold

59
Breusch-Godfrey Test for UK Retail OLS

• As can be seen, we fail to reject the Breusch Godfrey test which means the
errors have no auto correlation

• This is a condition for OLS to hold

60
Goldfeld-Quandt Test for Barclays RWA OLS

• As can be seen, we fail to reject the Goldfeld-Quandt test which means the
errors have constant variance i.e. homoscedasticity

• This is a condition for OLS to hold

61
Breusch-Pagan Test for Barclays RWA OLS

• As can be seen, we fail to reject the Breusch Pagan test which means the
errors have constant variance i.e. homoscedasticity

• This is a condition for OLS to hold

62
Breusch-Godfrey Test for Barclays RWA OLS

• As can be seen, we fail to reject the Breusch Godfrey test which means the
errors have no auto correlation

• This is a condition for OLS to hold

63
Asia Retail Operational Losses – Correlation Matrix

Variable Correlation
CPI_SouthAsia_D2_L3 -0.498455360
CPI_SouthAsia_BoxCoxD1_L3 -0.458362079
HK.Residential.Property.Price_D2_L3 -0.405147394
CPI_EastAsia.Pacific_BoxCoxD1_L3 -0.397744384
HK_unemplo_D2_L3 0.372868674

• 6 independent variables for Asia, 4 of which are highly correlated.

• Modelling with these 4 together would distort our results due to multicollinearity.

• Table on the right shows the variables with the highest correlations with our operational loss
data with 1st difference.
64
 Asian Retail Operational Losses – Correlation OLS Results

• Based on the coefficients and their p-values, only CPI_SouthAsia_D2_L3 is a statistically significant
value in predicting our dependent variable.

• Adjusted R-squared is somewhat low and no better than our univariate OLS results.

• P-value > 0.05 means that we cannot reject the null hypothesis that regression coefficients are
insignificant.

65
 Asian Retail Operational Losses – ARIMA-X Results

• Despite the results of our correlation OLS, our ARIMA model exhibits better results than that of our
univariate OLS model.

• ARIMA(0,0,1) predicted like our results above.

• Lower AICC and better results for RMSE and MAPE while passing the Ljung-Box test.

• Hard to say whether we can use this version of the model since CPI_SouthAsia, CPI_EastAsia,
HK_Residential_Property_Price and HK_unemployment are so highly correlated with each other.
66
Asian Retail Operational Losses – PCA OLS Results

• We tried to conduct OLS on PCA variables but the results were less than ideal, to say the least.

67
Check for Co-integration and dependencies using Correlation Matrix

68
Checking for Co-integration among variables

69
STATISTICAL ANALYSIS

Goodness of Fit – Adjusted R Square

Stationary - KPSS

Variable Significance - 5% of significance

Multi-Collinearity - VIF

Residual Autocorrelation – Q-statistic & Durbin Watson

Residual Normality – Q-Q Plot

Residuals Homoscedasticity – GQ Test

70
 REFERENCES
Abdymomunov, A., Curti, F., and Mihov, A. 2020. U.S. banking sector operational losses and the macroeconomic environment. Journal of Money,
Credit and Banking, 52(1):115-144. http://dx.doi.org/10.1111/jmcb.12661

Abdymomunov, A. and Mihov, A. 2019. Operational risk and risk management quality: Evidence from U.S. bank holding companies. Journal of
Financial Services Research, 56(1):73-93. http://dx.doi.org/10.1007/s10693-017-0284-3

Afonso, G., Curti, F., and Mihov, A. 2019. Coming to terms with operational risk. Federal Reserve Bank of New York Liberty Street Economics.

Berger, A., Curti, F., Mihov, A., and Sedunov, J. 2022. Operational risk is more systemic than you think: Evidence from U.S. bank holding
companies. Journal of Banking & Finance, forthcoming. http://dx.doi.org/10.1016/j.jbankfin.2022.106619

Curti, F., Frame, W. S., and Mihov, A. 2021. Are the largest banking organizations operationally more risky? Journal of Money, Credit and Banking,
forthcoming. http://dx.doi.org/10.1111/jmcb.12933
Curti, F., Fauver, L., and Mihov, A. 2022. Workforce policies and operational risk: Evidence from U.S. bank holding companies. Journal of Financial
and Quantitative Analysis, forthcoming. http://dx.doi.org/10.2139/ssrn.3747134

Curti, F., and Mihov, A. 2021. Catch the thief! Fraud in the U.S. banking industry. Working paper. http://dx.doi.org/10.2139/ssrn.3535934
Daniel Alifano, Valentina Corradi, Walter Distaso. 2019. The Determinants of Operational Risk Losses

Jankowitsch, Rainer, Florian Nagler, and Marti G. Subrahmanyam. 2014. The determinants of recovery rates in the U.S. corporate bond market.
Journal of Financial Economics, 114(1): 155-177. https://doi.org/10.1016/j.jfineco.2014.06.001

Nikki Cornwell, Christopher Bilson 2023. Modernizing operational risk management in financial ins institutions via data-driven causal factors
analysis: A pre-registered study. Pacific-Basin Finance Journal. http:// www.Elsevier.com/locate/pacfin

Raphael, S. and Winter-Ebmer, R. 2001. Identifying the effect of unemployment on crime. Journal of Law & Economics, 44(1): 259-283.
http://dx.doi.org/10.1086/320275

Wang, T. and Hsu, C. 2013. Board composition and operational risk events of financial institutions. Journal of Banking & Fina nce, 37(6): 2042-
2051. http://dx.doi.org/10.1016/j.jbankfin.2013.01.027