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?

Insurance risk Signup and view all the answers

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

Credit risk 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?

Transactional errors Signup and view all the answers

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

Strategic risk Signup and view all the answers

Which of the following is NOT a boundary example?

Boundary Example 2 Signup and view all the answers

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

In any form with intrinsic value Signup and view all the answers

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

In the late 1990s Signup and view all the answers

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

Internationally active banks Signup and view all the answers

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

Non-financial services Signup and view all the answers

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

Health and safety practices Signup and view all the answers

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

Business benefits and regulatory drivers Signup and view all the answers

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

To manage operational risks within business activities Signup and view all the answers

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

Preventing harm to customers Signup and view all the answers

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

The understanding of key fundamentals Signup and view all the answers

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

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

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

Strategic and reputation risk Signup and view all the answers

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

Call centre staff providing incorrect advice to customers Signup and view all the answers

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

Causal Signup and view all the answers

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

A system failure resulting in data loss Signup and view all the answers

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

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

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

To focus on the key fundamentals of operational risk management Signup and view all the answers

What is Risk Acceptance?

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

What is the primary goal of Risk Reduction?

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

What is Risk Transfer also known as?

Risk Sharing Signup and view all the answers

What is the main limitation of Risk Transfer?

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

What is the primary goal of Risk Avoidance?

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

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

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

What is the purpose of Risk Monitoring/Reporting?

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

What is monitored in Risk Monitoring/Reporting?

Changes to certain risks and the controls in place to manage the risks. Signup and view all the answers

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

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

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

Third line of defence Signup and view all the answers

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

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

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

Clear escalation structures and reporting lines Signup and view all the answers

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

To oversee and challenge the business in its risk management activities Signup and view all the answers

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

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

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

Information security risk assessments Signup and view all the answers

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

To support risk management activities and ensure that risks are managed appropriately 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.