Chapter 9 Key Learning Questions

Question 1

Key aspects considered by regulators in prioritizing supervision activities

Answer 1

Regulators prioritize supervision activities for operational risk management by considering their own risk appetite and a risk-based approach that assesses the probability and impact of events that may affect their statutory objectives, such as preserving market stability or protecting customers. The integration of prudential and conduct supervision is a key issue, with some jurisdictions combining these functions within one institution, while others separate them. The treatment of retail customers fairly and transparently is viewed as a key operational risk, given the potential for large fines and remedial actions​​.

Question 2

Importance of operational risk management beyond regulatory capital

Answer 2

The Basel Committee on Banking Supervision emphasizes that the management of operational risk in banks goes beyond merely setting appropriate capital adequacy rules. This perspective has led to significant advancements in capital adequacy rules for banks’ operational risk over the first decade of the century. The emergence of IT, outsourcing, and securitization introduced new risk exposures, legal, and documentation risks. Therefore, the focus is on qualitative and management techniques alongside capital adequacy measures to ensure a comprehensive approach to operational risk management​​.

Question 3

Key regulatory guidelines that apply to firms

Answer 3

Firms must adhere to the guidelines and approaches outlined by the Basel Committee on Banking Supervision for banks, and the Solvency II directive for insurance firms within the European Economic Area.

The Basel Committee offers four approaches for setting Pillar 1 capital requirements against operational risk: Basic Indicator Approach, Standardised Approach, The Alternative Standardised Approach, and Advanced Measurement Approach.

Solvency II sets a requirement for insurance firms to hold capital based on a 99.5% confidence level over a one-year period and specifies a standardized calculation for the Solvency Capital Requirement without allowing any offset for diversification with other risk types​​.