Chapter 1 Learning Outcomes

Question 1

Understand the fundamentals of operational risk management

Answer 1

1) Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This includes legal risk but excludes strategic and reputation risks
2) Key components of an operational risk framework include risk identification, assessment, response, monitoring and reporting. This is supported by governance structures, risk and control assessments, risk indicators, loss event data, scenario analysis and modelling.
3) Operational risk emerged as a distinct risk type with Basel II regulations for banks, but the concepts are now widely adopted across financial services and non-financial services firms

Question 2

Examine the definition of operational risk

Answer 2

The Basel II definition focuses on four key causal factors - people, processes, systems and external events. Anything caused by these can be considered operational risk.

Operational risk includes expected inherent risks and unexpected rare risks. Expected risks recur frequently as part of the business model.

Question 3

Identify the common risk types

Answer 3

Major risk types are strategic, credit, market, liquidity, insurance and operational risk. Risk boundaries determine whether a risk maps to operational or other risk types

Question 4

Explain the relationship between operational risk and other risk types

Answer 4

Risks can map to multiple categories. The causal factors determine inclusion under operational risk. If causes involve people, process, systems or external non-economic events, the risk maps to operational

Question 5

Explain the different manifestations of operational risk within a firm

Answer 5

Operational risk can manifest in many areas including IT, financial crime, business continuity, health and safety, compliance etc. Risks often span multiple categories.

Question 6

Explain the relationship between cause, event and impact.

Answer 6

The bow tie model shows causal factors lead to risk events, which then drive impacts. Controls sit between these components

Question 7

Examine the key components of the operational risk framework and governance structures

Answer 7

The framework covers risk assessments, loss event data, indicators, scenario analysis and modelling. Governance supports three lines of defence - business, oversight and audit