Practical Calculation of Expected and Unexpected Losses in Operational Risk by Simulation Methods
Introduction
One of the most difficult tasks in risk management is to set the appropriate level of capital to cover unexpected losses in banks and other financial institutions. Whereas expected losses can be described as the “usual” or average losses that an institution incurs in its natural course of business, unexpected losses are deviations from the average that may put an institution’s stability at risk. Not only risk managers are worried about these types of losses, but also regulators and financial supervisors, hence international standards are being continuously developed and improved to prevent institutions from going bankrupt due to these large potential losses. The most widespread of these standards is The New Basel Capital. Accord, also known as Basel II.