Foundations of Financial Risk: An Overview of Financial Risk and Risk-based Financial Regulation, 2nd Edition

CHAPTER 7 Operational Risk

Operational risks are present in virtually all bank transactions and activities and are a major concern of bank supervisors, regulators, and bank man­agement. Failing to understand operational risk increases the likelihood that risks will go unrecognized and uncontrolled, resulting in potentially devas­tating losses for the bank.

Chapter Outline

• 7.1 What Is Operational Risk?
• 7.2 Operational Risk Events
• 7.3 Operational Loss Events
• 7.4 Operational Risk Management
• 7.5 Basel II and Operational Risk

Key Learning Points

• Operational risks are inherent in business and reflect losses from inade­quate or failed internal processes, systems, human error, or external events.
• The Basel II Accord identifies five different operational risk events: internal process risk, people risk, legal risk, external risk, and systems risk. These risks are interrelated.
• Operational risk events are characterized by their frequency and impact on the operations of the bank. Banks focus their operational risk man­agement on high-frequency/low-impact risks and low-frequency/high-impact risks.
• Operational risk inventory that collects information on operational risk events can be either top-down or bottom-up.
• The Basel II Accord provides three different approaches to calculate operational risk capital: the Basic Indicator Approach, the Standardized Approach, and the Advanced Measurement Approach.

OPERATIONAL RISK

7.1 What Is Operational Risk?

Operational risk relates both to ...