Chapter 20 - Analysis of operational risk

Question 1

Benefits of effective operational risk management

Answer 1

Dr Drs

Desired Business objective
Reputational risk minimised

Day to day losses minimised
Regulatory compliance
Strengthen ERM framework

Question 2

Bottom up models

Answer 2

Low level categories, aggregated up
Data issues - lack, insufficient

Gives robust picture of company’s risk profile
External data may not be relevant
Breaking down into constituents is difficult
Historical data not robust (low prob, high impact)

Question 3

Top down models

Answer 3

Implied capital model:
Forward looking, ignores interrelationships, total risk capital needs to be calculated,
Operational Risk Capital = Total RC -Market RC-Credit RC-Other

Income volatility model:
Op RC=Total income volatility-Credit RIV-Market IncVol-Mort and other risk IV
Ignores rapid evolution of business, ignores softer issues such as brand and opportunity cost

Economic pricing model:
CAPM most widely used-assumes all market info included in share price
Impact of operational loss taken by stripping out market movement
Tail-end risk not accounted for properly; doesn’t anticpate incidents of OR; OR capital unaffected by controls in place

Analogue model:
Derive operational risk capital from data of similar companies

Question 4

Tools and techniques to assess, measure and manage operational risks

Answer 4

Loss incident database

Control self-assessment

Risk mapping

Risk indicators and performance triggers

Question 5

Why is operational risk difficult to assess?

Answer 5

Difficult to establish nature of some operational risks

Often low probability events

Hard to quantify

Lack of internal data

Difficult to obtain relevant external operational risk data

Lack of expertise, time constraints