Unit 3 - Topic 3

Question 1

What is Operational risk?

Answer 1

It is the risk of loss from operational failure

Question 2

4 points - What are the various types of operational loss events?

Answer 2

Acts of nature
Unintentional document execution errors
Conscious violations of law and regulation
Direct and Indirect acts of excessive risk taking

Question 3

3 points - What are the 3 lines of defence model key areas?

Answer 3

Identify, Measure and Mitigate

Question 4

4 points - What recognised as changes required for risk?

Answer 4

Recognising the world has changed rapidly
Expensive and significant control frameworks
Culture of business needs overhaul
Business models need changing

Question 5

2 points - Who originally used the 3 lines of defence model?

Answer 5

FSA then larger banks followed suit
The greater the number of stakeholders involved in a business, the greater the need for a resilient and transparent risk management model.

Question 6

2 points - What is the 1st line of defence and their correct actions?

Answer 6

Business Operations
- Operational management owns and manages the risk

Corrective actions:
Actions to address
Process
Control Deficiencies

Question 7

4 points - What is the 2nd line of defence?

Answer 7

Control functions
Does not always provide risk management as a single line in defence - acts as monitoring, advisory and consultative support for the 1st line.
- Risk management committee (Chief risk officer that reports to senior management), has risk reports.
- Compliance function that reports to the board or senior management
- Finance function - monitors financial risk and financial reporting issues
- Security function - physical and data security, inspection and quality function (Anti money laundering checks).

Question 8

3 points - What is the 3rd line of defence?

Answer 8

Internal audit
This provides the board and senior management with comprehensive assurance based on the highest level
Bank owned asset funders have extensive 3rd line of defence
- Reports independently to board or audit committee
- Might include internal audit or chief risk offices
- Shows how effective 1st and 2nd line has been

Question 9

4 points - Criticisms of the 3 lines of defence model?

Answer 9

Misaligned incentives for risk takers in the 1st line of defence
Lack of organisational independence in 2nd line
Lack of skills and expertise in the 2nd line
Inadequate and subjective risk assessment performed by internal audit

Question 10

3 points - What is missing from the defence model?

Answer 10

Business Unit managers
Risk and Compliance
External Audit

Question 11

3 points - What are the additional lines of defence?

Answer 11

External auditors - ‘relationship of oversight to the 1st line’
Board
Regulators

Question 12

4 points - What must the four lines model consider?

Answer 12

The roles, responsibilities, interactions between:
Internal and External audit
Regulatory financial supervisors
Model is only as strong as the people who work within it
Smaller organisations these models can be expensive to implement

Question 13

5 points - What is risk management? - DIMER

Answer 13

Identify and define their risks
Quantify and measure the level of risk and residual risk
Develop and document clear mitigation strategies
Implement risk reporting and monitoring
Establish appropriate governance monitoring and control

Question 14

10 points - Basic Risk Framework?

Answer 14

The organisations Strategic Objectives

Risk Assessment
- Risk analysis

Risk Identification
Risk description
Risk Estimation

Risk Evaluation

Risk Reporting
- Threats and opportunities

Decision

Risk Treatment

Residual risk reporting

Monitoring

Question 15

4 points - What are the operational areas asset funders must look at risk?

Answer 15

Product delivery
Customer sales
On boarding new customers
In-life and default management

Question 16

4 points - What are the factors to consider for asset funders before looking at risk?

Answer 16

Nature of its activities
Market it serves
The range of lending products it sells
The process and systems it uses

Question 17

3 points - What are the concerns of asset funders?

Answer 17

Internal process failures

Failures in operating systems and the actions or inactions of its people

Question 18

3 points - Types of operational risk?

Answer 18

Legal and compliance risk - risk of financial loss from the government or regulatory environment, compliance failure or conduct, etc
Strategic Risk - Failure to integrate activities with its business plans, strategic goals and direction.
Reputational risk - The risk in the eyes of the customer/investors - operational risk that weakens this such as ethical conduct, weak governance.

Question 19

What was the result of the LIBOR scandal?

Answer 19

Highlighted the need for whistleblowers

Question 20

What is credit risk?

Answer 20

When a lessor suffers financial loss due to the lessee not making repayments

Question 21

What do they look at for credit risk management?

Answer 21

They look at their own risk appetite against the clients business strategic objectives

Question 22

2 points - How do they mitigate credit risk?

Answer 22

Ability for lessor to repossess

Vendor relationship can reduce lessors arrears as they build dialogue with the client

Question 23

2 points - Residual risk what is it?

Answer 23

Lessor suffers financial loss that means they don’t expect to get their residual value on disposal even if customer defaults
If early termination the funder could be more at risk of this due to the market

Question 24

2 points - How do they mitigate residual risk?

Answer 24

Vendor ‘buyback guarantee’

In a voluntary termination, lessor will mitigate residual risk through calculating the termination rental

Question 25

2 points - What is currency risk?

Answer 25

Losses due to fluctuations in exchange rate

Can be at inception due to paying foreign supplier to purchase the asset

Question 26

2 points - How to mitigate currency risk?

Answer 26

Minimise by requiring the lessee to make payment on its behalf under agency arrangement, thus transferring currency risk to the lessee
Losses to the lessor could be offset over the term of the lease but short term it could distort lessor balance sheet

Question 27

3 points - Interest rate risk what is it?

Answer 27

Changes in the market interest rates could affect lessors earnings on fixed rate leasing transactions
Affects lessors cash flows and net present value of those cash flows - money worth less
Early termination or upgrade exposes lessor if funding costs change

Question 28

How to mitigate interest rate risks?

Answer 28

Efficient interest rate management across all areas of the bank - renegotiated leases should be base on current pricing to protect lessors return on capital

Question 29

2 points - Settlement risk what is it and how to mitigate it?

Answer 29

Lessor is at risk of an early unscheduled termination by lessee
Termination figure should compensate the lessors lost income

Question 30

2 points - Liquidity risk what is it?

Answer 30

Lessor fails to maintain cash flow required to repay its own borrowings
2007/8 saw many funders unable to access funding or compelled to access funding or compelled to accept very high market pricing to secure funds

Question 31

2 points - Mitigating liquidity risk?

Answer 31

Effective liquidity management - the process of forecasting funding requirements to meet changes in lessor mix of asset and liabilities
Requires daily analysis of the timing of cash inflows and outflows

Question 32

5 points - Considerations for lessors receiving broker approval?

Answer 32

Conduct, competence and financial standing of the broker and its principals
Brokers customer service reputation and complaint handling procedure
Customer and asset types are likely to be introduced, (geographical location, sector, industry, asset type)
Brokers relationship with other asset funders/manufacturers and dealers

Question 33

2 points - What are the FCA authorisations for risk responsibility of broker and funder relationships?

Answer 33

Verification of appropriate Broker Consumer Credit Act licensing approvals
Verification of broker compliance with GDPR requirements

Question 34

3 points - What are are the checks by the funder during a broker relationship?

Answer 34

- Broker agreement:
FCA regulations
Event of early termination or default
GDPR extended 
- Regular Monitoring via Management information:
Introducer volume
Asset types
Bad Debt write off
Customer account conduct
- Regular internal reviews

Question 35

3 points - What does internal reviews achieve for the broker relationship?

Answer 35

Better credit quality
Grow lending in line with funders strategic goals
Ensures business conducted in a professional and compliant manner