Case study

Nationwide Building Society

Implementing risk-sensitive operational risk capital allocations

Nationwide had an existing framework for the allocation of capital for credit, market, operational, business and insurance risk. However, the allocation of capital for operational risk was calculated as a multiple of revenue in each business, much like the Basic and Standardized approaches in the new Basel Accord. The Society felt that this approach had a number of shortcomings. For example, it linked capital requirements to a single scalar (revenue), lacked risk sensitivity, failed to provide business units with an incentive to manage operational risks, and Nationwide was unable to use it to provide quantitative risk-related input to key business decisions. As a result, there was little or no senior management buy-in to capital allocations for operational risks.

PA Consulting Group was asked to assist in developing a capital allocation methodology for operational risk that addressed these issues and promoted risk-mitigating behavior within business units. The methodology needed to be highly cost-effective, without the investment usually needed to implement Basel’s Advanced Measurement Approach (AMA).

Although no substitute for a full Basel AMA model, the framework represents a significant and cost-effective step forward for Nationwide