Risk Capital Aggregation

This article presents a new approach to determine the total risk of a financial institution. The proposed model includes components for credit, market, operational and business risk. Moreover it includes a component for the ownership risk that stems from holding a life insurance company. The approach may be characterised as a base-level aggregation method. However, due to lack of appropriate data, some of the aggregation steps are done on the top level instead. The economic risk factors used in the base-level aggregation are described by a multivariate GARCH model with Student’s t-distributed innovations. The loss distributions for the different risk types are determined by non-linear functions of the fluctuations in the risk factors. Hence, these marginal loss distributions are indirectly correlated through the relationship between the risk factors. The model was originally developed for DnB NOR, the largest financial institution in Norway, and one of the largest ones in the Nordic region. Being adapted to the requirements in the Basel II regulations, it will play an important part in measuring and assessing the risk level of the institution.