One aspect of operational risk that is often missed is the effects on banks of a pandemic. This is just the sort of “long tail” statistical event that VaR modelling will miss. As happened with the SARS epidemic in South-East and East Asia a few years ago, a contageous disease outbreak will cause some very unusual effects. How would your bank or company cope with a serious influenza pandemic, for example?
A simulation being run over the next few months in London is a good step towards ensuring that a pandemic is not going to completely cripple the financial system, multiplying what would have been a serious problem, with tragic effects for those directly affected, into a global crisis.
The assumptions behind these sorts of simulations are fairly simple:
- A reasonably large, but not overwhelming, number of people actually catch the disease. It may only be 1% of the population;
- The disease is known, or suspected, to be airborne and easy to catch;
- The disease causes at least a few fatalities; and
- People tend to react more strongly to the risk than strict logic would indicate.
These sorts of scenarios can severly try a financial system, as crucial people stop turning up to work – because they, or a family member are already sick or to try to avoid catching the illness. Many may be able to continue at least part time work from home – unless they themselves are sick – and this should limit the effects, but having a clearly established plan, some procedures and running a simulation or two would not be unwise.
The important thing to remember is that the number of people who actually get sick may be small, but the effects of assumption 4 mean that the results of the illness is multiplied for the duration of the crisis.
Trying to force your employees into work while a pandemic is on would be tricky.