Operational Risk Regulation in Banking

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Questions and Answers

What is the primary purpose of thematic on-site visits by supervisors?

To conduct a comprehensive review of all operational risks in detail

To cover specific operational risks and suggest industry-wide improvements (correct)

To implement new regulations for financial institutions

To evaluate the financial stability of individual firms

Which operational risk did supervisors focused on after 9/11?

Financial crime risk

Cyber-crime risk

Business continuity management (correct)

Documentation risk

How do supervisory bodies typically manage the supervision of operational risks?

By relying solely on their internal staff

By hiring external consultants with expertise in specific areas as needed (correct)

By creating specialized teams that cover all aspects of operational risk

By designing rigid and unchangeable procedures

What is a common approach taken by supervisors when issuing guidance on operational risk?

Linking their policies to documents from various standard-setters (C) Signup and view all the answers

What shift in focus occurred in supervisory practices following the 2007-9 crisis?

Increased oversight on documentation risks in businesses (B) Signup and view all the answers

What resource limitation do supervisory bodies typically face in operational risk supervision?

They cannot cover every aspect of operational risk in detail (B) Signup and view all the answers

What is the primary role of the Basel Committee?

To set guidelines for internationally active banks (B) Signup and view all the answers

Which of the following countries is NOT a member of the Basel Committee?

New Zealand (A) Signup and view all the answers

What is a significant limitation of the Basel Committee's authority?

It lacks treaty status and binding authority (B) Signup and view all the answers

How has the membership of the Basel Committee changed since its establishment?

It has expanded to include more nations beyond the G10 (A) Signup and view all the answers

What has become a top concern for regulators since 9/11 regarding financial firms?

Business continuity management (B) Signup and view all the answers

What organization is the Basel Committee a part of?

Bank for International Settlements (B) Signup and view all the answers

What was one of the original purposes of the Bank for International Settlements?

To facilitate the payment of German reparations (B) Signup and view all the answers

What regulatory measure has been introduced to assess the preparedness of financial firms?

Periodic testing of business continuity plans (A) Signup and view all the answers

Which risk has led regulators to enhance their focus on legal procedures and documentation?

Legal and documentation risk (A) Signup and view all the answers

What type of scenario is used by regulators to test business continuity in financial firms?

Hypothetical terrorist attacks (C) Signup and view all the answers

Which document outlines the regulatory principles for business continuity?

High-Level Principles for Business Continuity (C) Signup and view all the answers

What is the purpose of involving general counsel in the first line of defense for firms?

To address legal risks effectively (D) Signup and view all the answers

What principle is emphasized for regulators in the context of operational risk?

Holding senior executives and board members accountable (A) Signup and view all the answers

What has been the recent focus of supervisory visits by regulators?

Operational risk management practices (C) Signup and view all the answers

What is expected of firms in their relationship with regulators?

To cooperate and respond positively to supervisory signals (B) Signup and view all the answers

What can happen to a firm that fails to cooperate with regulators?

Potential regulatory fines or enforcement actions (C) Signup and view all the answers

Which of the following scandals significantly impacted the banking industry?

LIBOR and foreign exchange market rigging scandals (C) Signup and view all the answers

What is considered a privilege rather than a right in the context of financial services?

Licensing to provide financial services (C) Signup and view all the answers

What is the primary reason for replacing the previous approaches to operational risk with the new standardised approach?

To establish a uniform method for assessing operational risk across banks (B) Signup and view all the answers

When did the new standardised approach to operational risk come into effect?

January 1, 2022 (D) Signup and view all the answers

Which component is NOT part of the Business Indicator (BI) used in calculating operational risk capital?

Market volatility component (D) Signup and view all the answers

What does the operational risk capital formula 'Operational risk capital = BIC x ILM' signify?

Operational risk capital is a product of the Business Indicator Component and the Internal Loss Multiplier (B) Signup and view all the answers

What do commentators incorrectly refer to the new approach to operational risk as?

Standardised Measurement Approach (SMA) (C) Signup and view all the answers

What has been a significant concern regarding the old Advanced Measurement Approach (AMA)?

It was often manipulated by banks to report lower risk (C) Signup and view all the answers

Study Notes

Regulatory Influences on Operational Risk

The Basel Committee on Banking Supervision, located at the Bank for International Settlements, shapes global banking regulations.
Initially comprised of G10 countries, its membership now includes additional countries such as Brazil, China, and South Africa.
The Committee sets guidelines aimed primarily at internationally active banks, which have evolved into global standards, influencing regulations like the EU Capital Directives.

Supervision of Operational Risk by National Authorities

National supervisory bodies utilize staff with specialized skills or external consultants for detailed operational risk analysis.
Resources are allocated based on current threats, with increased focus on business continuity post-9/11 and documentation risk after the financial crisis.
Supervisors enforce policies and guidance linked to international standards, with approaches varying based on local legal culture.
Emphasis is placed on corporate governance, holding senior executives accountable for operational risk management.

Regulatory Compliance and Enforcement

Regulators prefer cooperative relationships with firms, expecting positive responses to supervisory signals; failure can lead to escalating powers and enforcement actions.
Major financial scandals (e.g., LIBOR and foreign exchange manipulation) have prompted hefty fines and intensified regulatory scrutiny.
Outsourcing is now a critical aspect of supervision, with regulators monitoring both the firms and the outsourced entities.

Key Operational Risks of Regulatory Concern

Business continuity management risk gained prominence after 9/11; firms must have and test effective plans in live scenarios.
Legal and documentation risks are increasingly scrutinized, ensuring that legal practices and documentation align with current standards.
Recent events have undermined regulatory confidence in banks' risk models, prompting a shift from the Advanced Measurement Approach (AMA) to a new standardized approach.

Operational Risk Capital Calculation for Banks

Basel III reforms were implemented to standardize operational risk capital requirements, effective January 1, 2022.
The operational risk capital formula is Operational risk capital = BIC x ILM, where:
- BIC (Business Indicator Component) incorporates three components: interest, leases and dividends; services; and financial components.
Focus is now on utilizing a bank’s income and historical losses to establish operational risk capital requirements.

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Description

Explore how national authorities oversee operational risk management and the regulatory framework for operational risk capital in banks. This quiz delves into key regulatory concerns associated with various types of operational risk. Test your knowledge of the complex regulatory landscape that impacts the banking sector.