Operational Risk is More Systemic than You Think: Evidence from US Bank Holding Companies

While operational risk is generally perceived as idiosyncratic with limited systemic implications, we doc-ument that operational risk threatens financial stability. Using supervisory data on large U.S. Bank Holding Companies (BHCs), we find operational losses increase systemic risk through a direct channel that impairs market values of loss-experiencing BHCs as well as a channel of correlated losses that impact multiple institutions simultaneously. Findings are driven by tail events, more pronounced for systemically impor-tant and closer-to-distress BHCs, and vary by business lines, event types, and financial/economic environ-ments. Our results extend the operational and systemic risk literatures and have key policy implications.(c) 2022 Elsevier B.V. All rights reserved.

Automated summary

This study reveals that operational risk poses a threat to financial stability by increasing systemic risk through direct and correlated channels. The impact is more significant for systemically important and distressed bank holding companies, and it varies depending on business lines, event types, and financial/economic environments.