Chapter 1

Overview and Definition

Learning objectives

After studying this chapter, you should be able to:

1 Understand how operational risk is defined by banking regulators, including the Hong Kong Monetary Authority (HKMA), and under Basel II

2 Distinguish operational risk from other types of risk, including market risk and credit risk, and from operations risk

3 Describe how Basel I and II approached operational risk and its inclusion as a factor in determining capital adequacy

4 Define operational risk management and discuss its drivers, activities, and related disciplines

5 Understand the HKMA approach to operational risk


Risk is an inherent part of the business of banking. It comes in various forms, each of which presents its own challenges to the proper functioning of a bank. One of the most all-encompassing of these risks is operational risk.

Operational risk in banks and other financial institutions did not become a focal point until the late 1990s and the work by the Bank for International Settlements’ Basel Committee on Banking Supervision (BCBS) to define it, as well as develop frameworks to manage it and provide regulatory options. Through Basel I and the subsequent Basel II, operational risk moved from a position well behind the curtain to a role on the center stage of banking operations. Over the past decade, operational risk has taken on even greater importance. The BCBS principles on operational risk management were honed and streamlined.

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