Measuring Operational Risk Exposures in Islamic Banking: A Proposed Measurement Approach

Abstract

The aim of the paper is to propose a model, namely Delta-Gamma Sensitivity Analysis-Extreme Value Theory (DGSA-EVT). DGSA-EVT is a model to measure HF-LS and LF-HS type of operational risks. The first leg of the proposed model, namely DGSA, is a methodology that deals with propagation of errors in the value adding activities which works by using measures of fluctuations in the activities.The sensitivities of the output, hence, are deployed to estimate the performance volatility. Furthermore, the second leg of the proposed model, Extreme Value Theory (EVT), is a technique to cater for an excess operational loss over a defined threshold which is normally characterized by low frequency and high severity (LF-HS) type of loss.