Operational Risk Modeling in Financial Services

CHAPTER 17A Scenario in Conduct Risk

17.1 DEFINITION

Most the analysis carried out in Part II of this book, and related to the importance of operational risk, can be explained by the consequences of the subprime mortgage crisis, and the huge fines that resulted from this crisis.

All these fines can be considered as related to conduct risk, as for instance the sales of mortgage-back securities, which are considered as mis-selling case.

According to Thomson-Reuters, financial institutions increasingly tend to adopt a separate working definition of conduct risk, as for instance 70% of G-SIFIs (Global Systemically Important Financial Institutions) have a separate definition of Conduct Risk.

However, among the 10 US and European institutions that paid almost $100 billion in fines and settlements to diverse bodies (DOJ, FDIC, State of New York, and so on) less than 50% explicitly propose a definition of conduct risk in their annual report.

Here is a sample of the definitions proposed:

1. The risk of detriment to customers, clients, market integrity, competition, or [the firm] from the inappropriate supply of financial services, including instances of wilful or negligent misconduct.
2. Conduct risk is the risk that [the firm's] employees or agents may (intentionally or through negligence) harm customers, clients, or the integrity of the markets, and thereby the integrity of the firm.
3. The risk that improper behavior or judgment by our employees may result in a negative financial, nonfinancial ...