The Moorad Choudhry Anthology, + Website

CHAPTER 7Understanding and Managing Operational Risk¹

“I think that people should be recognized for their achievements and the value that adds to society's progress. But it can be easily overdone. I think highly of many people and their accomplishments, but I don't believe that that should be paramount over the actual achievements themselves. Celebrity shouldn't supersede the things they've accomplished.”

—Neil Armstrong, quoted in James Hansen, First Man: The Life of Neil Armstrong, Simon & Schuster 2005

In this chapter, we introduce the concept of operational risk management in banking. Operational risk is as old as banking, but its management has only recently been given some of the focus afforded to credit, interest rate, market, and liquidity risk. For instance, in some banks operational risk was often simply placed in the same category as credit risk, despite it being markedly different. Measurement, modelling, and capital allocation associated with operational risk are challenging and are the topic of much debate. However, operational risk management requires focus because it is a driver of part of a bank’s regulatory capital requirement.

As with other risks, the Board of Directors should approve appropriate limits for specific and overall operational risk in the risk appetite statement.

OPERATIONAL RISK OVERVIEW

Whether huge and headline‐making or relatively small, banks suffer losses regularly from risks outside of credit, interest rates, and markets. In the 1990s, ...