Direct vs. Indirect Losses in Risk Management

As stated in its definition of operational risk, the Committee intends for the capital framework to shield institutions from both direct and certain indirect losses. At this stage, the Committee is unable to prescribe finally the scope of the charge in this respect. However, it is intended that the costs to fix an operational risk problem, payments to third parties and write downs generally would be included in calculating the loss incurred from the operational risk event. Furthermore, there may be other types of losses or events which should be reflected in the charge, such as near misses, latent losses or contingent losses. Further analysis is needed on whether and how to address these events/losses. The costs of improvement in controls, preventative action and quality assurance, and investment in new systems would not be included.

In practice, such distinctions are difficult as there is often a high degree of ambiguity inherent in the process of categorising losses and costs, which may result in omission or double counting problems. The Committee is cognisant of the difficulties in determining the scope of the charge and is seeking comment on how to better specify the loss types for inclusion in a more refined definition of operational risk. Further, it is likely that detailed guidance on loss categorisation and allocation of losses by risk type will need to be produced, to allow the development of more advanced approaches to operational risk, and the Committee is also seeking detailed comment in this respect.