Operational Risk Introduction
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Questions and Answers

What type of risk is considered under operational risk management if caused by fraud related to lending facilities?

  • Credit risk (correct)
  • Liquidity risk
  • Market risk
  • Insurance risk
  • Which of the following is an example of a liquidity risk that should be considered under operational risk management?

  • Transactional errors
  • Forensic issues
  • Inadequate credit models
  • Non-economic factors (correct)
  • What is a common factor that determines whether a risk should be considered under operational risk management?

  • Economic factors
  • Internal processes
  • People, process, systems or non-economic external factors (correct)
  • Strategic decisions
  • Which type of risk should be considered under operational risk management if caused by errors in actuarial modelling?

    <p>Insurance risk</p> Signup and view all the answers

    What type of risk is considered under operational risk management if caused by inadequate collateral?

    <p>Credit risk</p> Signup and view all the answers

    Which of the following is an example of a market risk that should be considered under operational risk management?

    <p>Transactional errors</p> Signup and view all the answers

    What type of risk should be considered under operational risk management if caused by incomplete due diligence?

    <p>Strategic risk</p> Signup and view all the answers

    Which of the following is NOT a boundary example?

    <p>Boundary Example 2</p> Signup and view all the answers

    In what form of human endeavour or activity can operational risk exist?

    <p>In any form with intrinsic value</p> Signup and view all the answers

    When was the term operational risk first recognised as a discrete risk type?

    <p>In the late 1990s</p> Signup and view all the answers

    What was the primary intended audience for the operational risk management concepts in Basel II?

    <p>Internationally active banks</p> Signup and view all the answers

    Which of the following industries has historically invested significantly in managing operational risks?

    <p>Non-financial services</p> Signup and view all the answers

    What is a common practice in non-financial services firms?

    <p>Health and safety practices</p> Signup and view all the answers

    What is a benefit of managing operational risks in financial services firms?

    <p>Business benefits and regulatory drivers</p> Signup and view all the answers

    What is a goal of integrated operational risk management in financial organisations?

    <p>To manage operational risks within business activities</p> Signup and view all the answers

    What is a common area of operational risk management in non-financial services firms?

    <p>Preventing harm to customers</p> Signup and view all the answers

    What is the primary focus of the discipline of operational risk management?

    <p>The understanding of key fundamentals</p> Signup and view all the answers

    What is the definition of operational risk according to Basel II?

    <p>The risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events</p> Signup and view all the answers

    What is excluded from the definition of operational risk according to Basel II?

    <p>Strategic and reputation risk</p> Signup and view all the answers

    What is an example of operational risk arising from the 'people' causal factor?

    <p>Call centre staff providing incorrect advice to customers</p> Signup and view all the answers

    What is the nature of the Basel II definition of operational risk?

    <p>Causal</p> Signup and view all the answers

    What is an example of operational risk arising from the 'systems' causal factor?

    <p>A system failure resulting in data loss</p> Signup and view all the answers

    What is included in the Basel II definition of legal risk?

    <p>Private settlements and exposure to fines, penalties, or punitive damages</p> Signup and view all the answers

    What is the primary purpose of the chapter in the context of operational risk management?

    <p>To focus on the key fundamentals of operational risk management</p> Signup and view all the answers

    What is Risk Acceptance?

    <p>A risk response where a firm decides to accept the current level of risk exposure.</p> Signup and view all the answers

    What is the primary goal of Risk Reduction?

    <p>To reduce the likelihood and/or impact of a risk.</p> Signup and view all the answers

    What is Risk Transfer also known as?

    <p>Risk Sharing</p> Signup and view all the answers

    What is the main limitation of Risk Transfer?

    <p>The firm still owns the risk and may remain exposed to some of the financial exposure and all of the reputational exposure.</p> Signup and view all the answers

    What is the primary goal of Risk Avoidance?

    <p>To completely eliminate a risk by stopping certain activities.</p> Signup and view all the answers

    Who are the stakeholders that may need to be reported to after risk response decisions are made?

    <p>The Board members, Chief Executive Officer, Chief Risk Officer, Heads of Business Units, Internal Audit, and Regulators.</p> Signup and view all the answers

    What is the purpose of Risk Monitoring/Reporting?

    <p>To report the outcomes of risk response decisions to stakeholders.</p> Signup and view all the answers

    What is monitored in Risk Monitoring/Reporting?

    <p>Changes to certain risks and the controls in place to manage the risks.</p> Signup and view all the answers

    What is the primary responsibility of the first line of defence?

    <p>Identification, assessment, responding, monitoring, and reporting of its own risk</p> Signup and view all the answers

    Which line of defence is usually the firm's internal audit function?

    <p>Third line of defence</p> Signup and view all the answers

    What is the primary purpose of a risk and control self-assessment (RCSA) process?

    <p>To identify the risks a firm faces and its current exposure to those risks</p> Signup and view all the answers

    What is a key component of a firm's risk governance structure?

    <p>Clear escalation structures and reporting lines</p> Signup and view all the answers

    What is the purpose of a firm's central operational risk function?

    <p>To oversee and challenge the business in its risk management activities</p> Signup and view all the answers

    What is a key benefit of a clear escalation structure in a firm's risk governance structure?

    <p>It ensures that information on exposures flows back up to the most senior accountable officer in a timely manner</p> Signup and view all the answers

    What is a specialist form of risk assessment that firms may undertake?

    <p>Information security risk assessments</p> Signup and view all the answers

    What is the purpose of delegating accountability down the organisation structure?

    <p>To support risk management activities and ensure that risks are managed appropriately</p> Signup and view all the answers

    Study Notes

    Operational Risk Overview

    • Operational risk arises from internal processes, people, systems, or external events impacting organizations.
    • Recognized as a discrete risk type in the late 1990s with Basel II framework.
    • Initially focused on banks, now encompasses insurance and other financial sectors, including asset management and pensions.

    Risk Type Boundaries

    • Boundaries exist between operational risk and other risk types, requiring careful evaluation.
    • Credit Risk: Considered operational if resulting from fraud, procedural failures, inadequate collateral or credit models.
    • Market Risk: Included under operational if caused by transactional errors, fraud, or collateral issues.
    • Liquidity Risk: Relevant when due to forecasting issues or non-economic factors affecting investments.
    • Insurance Risk: Viewed as operational if caused by protocol failures, errors in actuarial assumptions, or poor documentation.
    • Strategic Risk: Classified under operational if stemming from poor business judgement or inadequate governance.

    Factors Influencing Operational Risk

    • Causal factors include processes, people, systems, and external elements.
    • Risks are also assessed based on their linking to human activity or system deficiencies.

    Definition and Components of Operational Risk

    • Defined based on losses from inadequate or failed processes, people, systems, or external events, including legal risks but excluding strategic and reputational risks.
    • Key causal factors include:
      • Processes: Errors due to poorly designed procedures.
      • People: Misconduct or negligence by employees.
      • Systems: Technical failures during operations.
      • External Factors: Market or environmental impacts.

    Risk Responses

    • Risk Acceptance: Accepting exposure within risk appetite without additional action.
    • Risk Reduction: Implementing measures to decrease likelihood or impact of risks.
    • Risk Transfer: Sharing exposure through insurance or contractual agreements, retaining some liability.
    • Risk Avoidance: Choosing to exit markets, discontinue products, or halt processes to eliminate risks.

    Risk Monitoring and Reporting

    • Monitoring of risks is essential post-decision-making to ensure stakeholders are informed.
    • Various stakeholders involved include Board members, Chief Risk Officers, and Regulators.
    • Requires ongoing assessment to proactively identify significant changes in risk profiles.

    Governance Structure in Risk Management

    • Three Lines of Defence Model:
      • First Line: Risk owners responsible for identifying, assessing, and managing risks.
      • Second Line: Independent oversight function ensuring effective risk management.
      • Third Line: Internal audit providing assurance on risk management practices.
    • Clear accountability and reporting lines are crucial for effective governance and risk management.

    Risk and Control Self-Assessment (RCSA)

    • RCSA is a primary methodology for firms to identify and evaluate risks and their exposures.
    • Specialty assessments include information security, IT security, and financial crime risk assessments to enhance risk management efforts.

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    Description

    This quiz introduces operational risk, its existence in various processes and systems, and its management.

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