In this chapter, we explore the most challenging element of the operational risk framework: risk appetite. The risk appetite element of the framework is the glue that holds the framework together, as it provides context for the risks that are identified and assessed and ensures appropriate escalation and governance of operational risk.
However, there is little guidance on operational risk appetite in the original Basel II documents and firms have struggled with this element in the past few years. Regulators have recently provided further guidance that makes it clear that the board of directors, senior management, and the businesses all have roles to play in setting and managing operational risk appetite. This guidance has proven helpful and firms are now making real progress in addressing this element of the framework, albeit with a wide range of practices.
THE ROLE OF RISK APPETITE
Operational risk management, measurement and capital modeling produce data, scores, and capital numbers that are designed to be used by the firm to identify, assess, monitor, control, and mitigate operational risk. All of these activities rely on an underlying understanding of the risk appetite of the firm.
Assessment of risk assumes that there is a gauge against which that assessment is measured. However, finding and expressing an operational risk appetite can prove to be very challenging. Unlike other risk categories, operational risk is inherent in the very existence of ...