Actuarial Modelling of Operational Risk in Nigerian Banks Using Advanced Measurement Approaches

This study applies actuarial loss modelling techniques to quantify operational risk in Nigerian commercial banks, examining the applicability of advanced measurement approaches under the Basel III framework. Operational risk, encompassing losses arising from failed processes, systems, human error, and external events, is a significant risk category for Nigerian banks given the prevalence of fraud, cybercrime, and regulatory compliance failures. Actuarial techniques developed for insurance loss modelling, including extreme value theory and compound distribution fitting, offer rigorous tools for operational risk quantification. This study uses operational loss event databases from five Nigerian commercial banks operating in Lagos and Abuja for the period 2016 to 2023, obtained under confidentiality agreements. Loss frequency and severity distributions are fitted for each Basel II event type category. Aggregate operational value-at-risk at 99.9 percent confidence level is computed using Monte Carlo simulation. Results are compared against banks' regulatory capital allocations under the basic indicator approach. Findings reveal that operational loss distributions in Nigerian banks exhibit heavy tails, particularly in external fraud and business disruption categories, with the 99.9 percent VaR estimate for the largest bank exceeding its basic indicator approach capital allocation by 34 percent. The study concludes that advanced actuarial measurement approaches identify higher operational capital requirements than simple regulatory formulas for large Nigerian banks. It recommends that the CBN pilot an advanced measurement approach framework for systemically important banks.

Keywords: operational risk, actuarial modelling, Nigerian banks, Basel III, extreme value theory.