An Introduction to Banking, 2nd Edition

Chapter 16MANAGING OPERATIONAL RISK

In this chapter we introduce the concept of operational risk management in banking. Operational risk is as old as banking, but its management has only recently been given some of the focus afforded to credit, interest rate, market, and liquidity risk due to regulator attention. In the past, operational risk was often simply placed in the same category as credit risk, despite it being different conceptually.

Measurement, modelling, and capital allocation associated with operational risk are challenging and are the topic of much debate. However, operational risk management continues to grow and be refined as a discipline in the face of losses in an increasingly complex banking environment driven by globalisation, regulation, and technology.

As with other risks, the Board of Directors should approve appropriate limits for specific and overall operational risk in the risk appetite statement.

OPERATIONAL RISK OVERVIEW

Whether huge and headline making or relatively small, banks suffer losses regularly from risks outside of credit, interest rates, and markets. In the 1990s, once the Basel Committee had determined that operational risk should be formalised as a concept in Basel II – with capital allocated against it – market participants made attempts to create a working definition. For many, operational risk was simply “other” risk, or a residual category for difficult to measure risk. Presently, most accept the Basel II definition of “the risk ...