LO 3.4: Com pare unified and compartmentalized risk measurement.

LO 3.4: Com pare unified and compartmentalized risk measurement.
Unified and compartmentalized risk measurement methods aggregate risks for banks. A compartmentalized approach sums risks separately, whereas a unified, or integrated, approach considers the interaction among risks.
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2018 Kaplan, Inc.
Topic 5 Cross Reference to GARP Assigned Reading – Basel Committee on Banking Supervision
A unified approach considers all risk categories simultaneously. This approach can capture possible compounding effects that are not considered when looking at individual risk measures in isolation. For example, unified approaches may consider market, credit, and operational risks all together.
When calculating capital requirements, banks use a compartmentalized approach, whereby capital requirements are calculated for individual risk types, such as market risk and credit risk. These stand-alone capital requirements are then summed in order to obtain the banks overall level of capital.
The Basel regulatory framework uses a building block approach, whereby a banks regulatory capital requirement is the sum of the capital requirements for various risk categories. Pillar 1 risk categories include market, credit, and operational risks. Pillar 2 risk categories incorporate concentration risks, stress tests, and other risks, such as liquidity, residual, and business risks.
Thus, the overall Basel approach to calculating capital requirements is a non-integrated approach to risk measurement. In contrast, an integrated approach would look at capital requirements for each of the risks simultaneously and account for potential risk correlations and interactions. Note that simply calculating individual risks and adding them together will not necessarily produce an accurate measure of true risk.
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