A Risk Professional's Survival Guide: Applied Best Practices in Risk Management

CHAPTER 15 Model, Regulatory, Legal, and Reputational Risk Management

OVERVIEW

Beyond managing traditional bank risks such as credit, market, liquidity, and operational risk, SifiBank cannot afford to ignore a host of ancillary risks that may result in significant losses associated with lost business and customer relationships, costly penalties, and restrictions on bank activities, among other negative outcomes. Four risks of particular interest are model, regulatory, legal, and reputational risk. What makes these risks somewhat different from the other risks facing SifiBank is that they do not lend themselves to easy quantification of their overall contribution to Sifibank aggregate risk exposure. For that reason, SifiBank risk management must rely more on effective processes and controls than on development of sophisticated analytics.

Further, these risks may come together under certain conditions to amplify risk exposure for the firm. For example, introduction of a new product for which the bank has limited to no experience might lead to a vast underestimation of credit risk due to model misspecification that could lead to higher than expected credit losses. In turn, poor operational controls on this product could lead to greater regulation and legal battles with customers, investors, and counterparties, and the ensuing negative publicity could damage the reputation of the company in the eyes of these same constituencies. Building in checkpoints allowing management to gauge ...