Operational risk and its relationship with institution size in the Hungarian banking sector

In addition to credit, market and liquidity risk, measuring and managing operational risk (risk associated with people, systems, processes and external events) is a great challenge for banks. In 2010, around HUF 35 billion in operational risk losses were reported in the banking sector overall, which is significant relative to the pre-tax profits of the banking sector. To a large extent, banks’ operational risk measurement methods rely on loss events which have already occurred. If an individual institution has insufficient data for modelling or wishes to include the experiences of extreme events, it should use external data or transpose the risk exposure of the banking sector onto itself. The empirical analysis of the Hungarian banking sector’s operational risk data confirms that, similarly to foreign banking sectors and banking groups (which have been already analysed in the relevant literature), there is a significant relationship in the Hungarian banking sector between institution size as defined by gross income and total operational risk losses recorded during the specific period. However, the most significant correlation can be observed between institution size and the frequency of operational risk losses. This result could provide basis for the systemic analysis of operational risk and support simpler operational risk capital allocation methods. Nonetheless, due to the relatively short time series and the significant dispersion of data, we could not robustly assess the sufficiency of the capital already allocated for operational risk.