You are on page 1of 15

Suggested Solutions

Assignment 01
Operational Risk Management




Department of Finance, Risk Management
and Banking
This tutorial letter contains important
information about your module.







RSK 4801





You have been appointed since the beginning of January as the Operational Risk Manager for
Benchmark Bank. In your first discussion with the Chief Risk Officer (CRO), she raised a concern
that the risks are not properly classified by the business units and that she is uncomfortable with the
accuracy of the loss reporting.

The CRO specifically requested you to analyse the reported losses and where necessary, correct
the information to reflect the losses more accurately for the annual report. You obtained the current
Loss Register and noticed that it is in a dire state. You decided to correct the Loss Register by
following the following steps in a table format:

Classify the losses according to the main risk types
Classify operational risk losses according to the operational risk sub-types
Convert foreign currency into South African Rand
Add the amounts to determine the frequency and total loss per risk category

Answer
The purpose of this assignment was to give students the opportunity to classify risks in terms of the
risk definitions and to demonstrate how difficult it sometimes is to classify risks, as the consequence
of the event can caused by a number of different factors. In practice, this is known as the boundary
effect.

Although it may appear to be trivial, the impact on the profitability of a department or division can be
impacted significantly due to loss events. Banks also have to calculate regulatory capital and for
operational risk capital, loss experience is one of the factors considered to calculate the capital. The
incorrect classification of risk can therefore have a significant impact on a department or division,
both from a profitability and regulatory capital aspect.

Below is the suggested solution for the classification of the events. We added an explanation
where there is a boundary effect. Work through the examples and ensure that you
understand the reasoning for the classification.





LOSS REGISTER: BENCHMARK BANK FOR THE YEAR ENDED 2014

DESCRIPTION CREDIT MARKET OPERATIONAL RISK EXPLANATION
PEOPLE PROCESS SYSTEMS EXTERNAL
Trader on the FX
desk processed
the transaction
as buy instead of
sell
Operational risk,
People
Finger trouble by a
trader
AML function
wrong directional
view on interest
rates. Loss on
swap curve.
Market risk The bank took a
wrong view on
interest rates and
positioned the book
of the bank
accordingly and the
lost was caused by
the change in
interest rates.
Bond options
trader captured
expiry date
wrong
Operational risk,
People

SAFEX penalty for
late margin calls.
Clearing House
official did not
contact broker
for payment.
Operational risk,
People
The official was
negligent by not
contacting the broker
for payment.

4

JSE penalty for
late bond
settlements.
Missed
settlement
window due to
offshore
counterparty
processing
transaction late.
Operational risk,
Process

Customer claim
for bad
derivatives
investment
advice
Operational risk,
People

Interest on late
Citi Bank
collateral calls.
Incorrect
calculation by
clerk
Operational risk,
People

Duplicate
payment to
Lloyds Bank
Operational risk,
People
Although the amount
of the loss was
influenced by the
change of the
currency, the
underlying cause was
the incorrect
payment.
Payment to
Sumitomo into
wrong act loss
was 156312 due
to change in
Operational risk,
People

RSK4801



5
currency
Payment fraud by
Triad syndicate
Operational risk,
External

JSE penalty for
late settlements.
Recon
outstanding for
cleared funds.
Operational risk,
Process

Goodwill
payment to Big
Shot Ltd because
business online
was down over
month end
Operational risk,
Systems

Fraud due to
sharing of
passwords by
payment staff
Operational risk,
People

Teller difference Operational risk,
People

Teller difference Operational risk,
People

Teller difference Operational risk,
People

Teller difference -
new teller
Operational risk,
People

Polokwane
branch
Operational risk,
People


6

Staff fraud Operational risk,
People

Fraudulent
payment by staff
member
Operational risk,
People

Cash centre Operational risk,
External

BA 800 submitted
incorrectly
Operational risk,
People

Teller difference Operational risk,
People

Teller difference Operational risk,
People

Stolen cheque
book Bob
Mugabe
Operational risk,
External

Loaded incorrect
ATM fee
increases for July
- EXCO decided
not to backdate
increases for
sensitivity to
reputational risk
Operational risk,
People

Staff fraud Operational risk,
People

Lost guarantee P
Pompies
Operational risk,
Process

BA 800 submitted
incorrectly (Jun)
Operational risk,
People

RSK4801



7
Irrecoverable
losses due to not
follow up of
excess reports
Operational risk,
People

Bad debt written
off: JMM
Construction
Credit risk
Bad debt written
off: BC
Construction
Supplies
Credit risk
Access payment
for motor car
accident claim
Operational risk,
People

Access payment
for motor car
accident claim
Operational risk,
People

Access payment
for motor car
accident claim
Operational risk,
People

Late registration
of bonds due to
strike -
penalties/interest
claims to
customers
Operational risk,
People

Staff fraud Operational risk,
People

Staff fraud Operational risk,
People

Teller difference Operational risk,
People


8

Teller difference Operational risk,
People

Interest claim by
client because of
bad service
(customer not
informed of
change in
interest rates)
Operational risk,
People

Commodities
trader captured
incorrect amount
Operational risk,
People

Write off due to
incorrect model
parameters on 5
year CDO
Operational risk,
Process

Embossing fraud
- card cloned CR
Operational risk,
External

Charge back
recon differences
Operational risk,
Process

Interest claim
due to late SWIFT
transfer
Operational risk,
People

Processing
official used
incorrect rate
Operational risk,
People

Damage to
premises due to
ATM bombings
(consolidated)
Operational risk,
External

ATM bombings
(money stolen)
Operational risk,
External

Branch teller
differences
Operational risk,
People

RSK4801



9

You needed to convert the foreign exchange in the loss register to South African Rand.

To convert American Dollar (USD) to rand, multiply the dollar amount with the exchange rate e.g. $1000 x 7.11789 = R7 117.89.
You can use the same principle for the other currencies.

DESCRIPTION CREDIT MARKET OPERATIONAL RISK
PEOPLE PROCESS SYSTEMS EXTERNAL
Trader on the FX desk processed
the transaction as buy instead of
sell
R236,423.89
AML function wrong directional
view on interest rates. Loss on
swap curve.
R1,573,035.00
Bond options trader captured
expiry date wrong
R948,672.54
SAFEX penalty for late margin
calls. Clearing House official did
not contact broker for payment.
R100,000.00
JSE penaly for late bond
settlements. Missed settlement
window due to offshore
counterparty processing
transaction late.
R150,000.00
customer cliam for bad derivatives
investment advice
R150,000.00
interest on late Citi Bank collateral
calls. Incorrect calculation by clerk
R387,562.00

10

DESCRIPTION CREDIT MARKET OPERATIONAL RISK
PEOPLE PROCESS SYSTEMS EXTERNAL
duplicate payment to Lloyds Bank R362,684.00
payement to Sumitomo into
wrong act loss was 156312 due
to change in currency
R17,679.31
payment fraud by triade syndicate R6,500,000.00
JSE penalty for late settlements.
Recon oustanding for cleared
funds.
R450,000.00
goodwill paymt to Big Shot Ltd
becuase business online was
down over month end
R600,000.00
fraud due to sharing of passwords
by payment staff
R300,000.00
teller difference R15,687.00
teller difference R5,962.00
teller difference R1,114.00
teller difference - new teller R214,509.00
polokwane branch R100,250.00
staff fraud R56,000.00
fruadulent payment by staff
member
R30,000.00
RSK4801



11
DESCRIPTION CREDIT MARKET OPERATIONAL RISK
PEOPLE PROCESS SYSTEMS EXTERNAL
cash centre R15,600,000.00
BA 800 submitted incorrectly R5,000.00
teller difference R32,418.00
teller difference R35,167.00
Stolen cheque book Bob Mugabe R10,000.00
Loaded incorrect ATM fee
increases for July - EXCO decided
not to backdate increases for
sensitivity to reputational risk
R235,145.00
staff fraud R342,190.00
Lost guarantee P Pompies R500,000.00
BA 800 submitted incorrectly (Jun) R10,000.00
Irrecoverable losses due to not
follow up of excess reports
R753,451.00
Bad debt written off: JMM
Construction
R2,567,000.00
Bad debt written off: BC
Construction Supplies
R654,789.00
Access payment for motor car
accident claim
R5,000.00

12

DESCRIPTION CREDIT MARKET OPERATIONAL RISK
PEOPLE PROCESS SYSTEMS EXTERNAL
Access payment for motor car
accident claim
R5,000.00
Access payment for motor car
accident claim
R5,000.00
Late registration of bonds due to
strike - penalties/interest claims
to customers
R105,678.00
staff fraud R10,300.00
staff fraud R53,800.00
teller difference R23,749.00
teller difference R43,671.00
interest claim by client because of
bad service (customer not
informed of change in interest
rates)
R73,421.00
commodities trader captured
incorrect amount
R493,598.96
write off due to incorrect model
parameters on 5 year CDO
R150,000.00
Embossing fraud - card cloned CR R15,000.00
Charge back recon differences R256,896.00
Interest claim due to late SWIFT
transfer
R15,352.00
RSK4801



13
DESCRIPTION CREDIT MARKET OPERATIONAL RISK
PEOPLE PROCESS SYSTEMS EXTERNAL
Processing official used incorrect
rate
R12,180.52
damage to premises due to atm
bombings (consolidated)
R7,000,000.00
ATM bombings (money stolen) R11,890,650.00
branch teller differences R165,631.00
TOTAL PER CATEGORY R3,221,789.00 R1,573,035.00 R5,352,296.22 R1,506,896.00 R600,000.00 R41,015,650.00
NUMBER OF EVENTS 2 1 35 5 1 6

Please keep in mind that this is a loss register. This implies that the balances of the register must agree with the corresponding account in the
general ledger. The bank will also base its BA reports on the information in this register. It was therefore important when you answered the
question to keep to the table format to enable the markers to review the register.






Analyse the losses per main risk type and illustrate with diagrams/graphs for discussion
with EXCO (15 Marks).

Students should have used descriptive statistics e.g. Pie charts, bar diagrams or line charts to
describe the volumes and values of the loss register.

At a main risk type level, the diagrams will show a concentration in operational risk in both the
values and volumes, followed by credit and market risk.

Further analysis of operational risk shows that:
the highest volume of losses (35) in the People category, with 6 external events, 5 process
events and 1 system event.
external events had the highest loss, followed by people, process and systems.

Some students went further and classified the operational risk sub categories in terms of the loss
event types i.e. internal fraud, external fraud and clients.


Conclusion
Based on the results of the assignment, some students seemed to find the assignment challenging.
The marks ranged from 90% to 4%.

The mistakes can be summarised as follows:
students did not classify the losses into the main risk types. The main risk types were
sometimes discussed, but the actual losses not classified. You need to know the risk definitions
to be able to identify and classify risks in the following assignments and the examination. Refer
to the study guide or the Basel documents for more clarity if you are uncertain regarding the risk
definitions.
losses were in some cases not classified into the four operational risk sub-risk types.
currency conversions were based on the incorrect amounts or were done incorrectly.
the diagrams/graphs were not always meaningful and will be difficult to explain to an EXCO. The
diagrams/graphs were also not always discussed.
Work was not always referenced.
Where students did reference work, it was limited to the prescribed book.

RSK4801



15
This module is offered at a postgraduate level. At a postgraduate level, students have to refer to
other sources than only the prescribed book in the assignments and as part of the preparation for
the examination. The study guide/notes in the Learning Units are your lectures and form the basis
for the course.

References
Blunden, T. Thirlwell, J. 2013. 2
nd
Edition. Mastering Operational Risk. Harlow Pearson
Education Ltd.
Sound Practices for the Management and Supervision of Operational Risk. Consultative
Document February 2011. Basel Committee on Banking Supervision.
www.bis.org/publ/bcbs183.htm (Accessed 2011/04/10).
Young, J. 2006. Operational Risk Management: The practical application of a qualitative
approach. Pretoria: Van Schaik Publishers.