Operational Risk Modeling in Financial Services

CHAPTER 5The Importance of Operational Risk

In this section we will analyse data related to operational risks to support three statements.

The first statement is that operational risk losses are important. This does not mean only that operational risk events did cost a lot in the past – which is true, but also that operational risk is not stable. We will demonstrate this using the example of the 2008 crisis.

The second statement is that operational risk capital is important.

The third statement is that operational risk is related to profit. It is often said that market and credit risks are directly related to the potential profit, but that operational risk is simply a negative risk that could be eliminated at no cost on the business. This is wrong – operational risk taking is directly related to the “speed” of business, and therefore drives profit.

5.1 THE IMPORTANCE OF LOSSES

There is a lot of literature tracing back the origins of creating a specific category for operational risk in banking.

A simple chronology shows that some large operational risk events, real or potential, such as the collapse of Barings Bank after Nick Leeson's rogue trading, the potential Y2K bug, or the terrorist attacks on September 11, 2001, may have reminded the regulators that banks operate in a physical environment, with buildings, systems, and people. Nonfinancial events can have consequences sometimes more serious than credit defaults or market volatility. If we look more carefully at this ...