Sub‐Optimality of Income Statement‐Based Methods for Measuring Operational Risk under Basel II: Empirical Evidence from Spanish Banks

Abstract

The New Basel Capital Accord (Basel II) was created with the intention of establishing a framework in which financial entities can manage their risks in a more detailed and efficient way. Within this general reform movement, Operational Risk emerges as a fundamental variable. OR can be managed by three alternative methods: the Basic Indicator Approach, Standard Approach and Advanced Measurement Approach. The choice of which method to adopt has become of supreme interest for senior banking managers. This study analyzes the exactitude of the underlying implicit hypotheses that support each method, distinguishing between income statement based methods and the management accounting based method. In the present study the non‐optimum character of the two Income Statement‐based methods is empirically confirmed, in the light of the data provided by Spanish financial entities.