1. Fundamentals of Operational Risk Flashcards
What is the definition of operational risk
‘risk of loss resulting from inadequate or failed internal processes, people and systems or from external events’.
This definition includes legal risk, but excludes strategic and reputation risk. Basel II explicitly frames legal risk as including (but not limited to) exposure to fines, penalties, or punitive damages resulting from supervisory actions, as well as private settlements.
Name the 4 main causal factors
P rocesses
P eople
S ystems
E xternal
Under Basel II what are the 7 risk event types that framework is divided into
D damage to Physical assets
i Internal fraud
e - employment practice and workplace safety
D - delivery and process management
e external fraud
b business disruption and system failures, execution 7.
C clients product and business practice,
Die Deb C
Name the common risk types
Strategic risk Credit risk Market risk Liquidity risk Insurance risk Operational risk
Explain Strategic risk
Uncertainties that may affect or may be created by an organisation’s business strategy and
strategic objectives. Examples of strategic risk include:
• Products offered by the organisation ma y not meet customer needs.
• Over-reliance on a single product f or revenue generation.
• Failure to anticipate a new competitor entering the market which intends to be very aggressive about acquiring market share .
Explain credit risk
The risk of loss due to counter party default. It is restricted to default or situations where the
counterparty can but refuses to make payment when due . Examples of credit risk include:
• A business is unable repay a loan because of the failure of a major creditor .
• A customer defaults on their mortgage payments as a result of redundancy .
• Insurance company is unable to claim on a reinsurer because the reinsurer is insolvent.
explain market risk
The risk of loss due to adverse economic changes in market conditions, rates or prices or
fluctuations in volatility. Market risk includes price risk, volatility risk, interest rate risk and
foreign exchange risk among other s. Examples of market risk include:
• Loss of revenue due to changes in exchange rates between sterling (GBP) and
euro (EUR).
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Risk Type Description
Market risk
• Losses in an in vestment portfolio due to significant drop in FTSE 100 index.
• Unexpected increase in debt-
explain liquidity risk
The r isk of not ha ving adequate funds a vailable to meet f inancial commitments as they
fall due . This ma y be caused b y local or f oreign economic conditions, a reduction in the
firm’s credit r ating, or situations where the f irm is interested in tr ading an asset b ut cannot
do so because nobody in the mar ket wants to tr ade that asset. Examples of liquidity
risk include:
• A significant change to the credit r ating of an or ganisation which ma y result in mater ial
withdrawal of funds b y customer s.
• A mater ial change to the credit r ating of a countr y which ma y result in panic
withdrawal of funds from all banks in the countr y which they cannot meet.
• Significant lev el of uncer tainty in the mar ket which ma y dr y up demand f or financial
instruments held b y the f irm.
explain insurance risk
Also known as underwriting risk. Insurance risk is the risk of a claim being made on an
insurance policy or underwriting. Examples of classes of insurance risk include: business
interruption, cyber crime, director s’ and officers’ liability, key man, motor (individual or
fleet), property, professional indemnity, terrorism, unauthorised trading, as w ell as life and
health policies.
explain operational risk
The risk of loss, direct or indirect, resulting from inadequate or failed internal processes,
people and systems or from external events. Examples of operational risk include:
• Accepting or offering bribe.
• Theft of customer data from IT Systems by hackers.
• Intentional mis-selling of products/services to clients.
