OPERATIONAL RISK

OUR GROUP

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1.

2.

Definition of
Operational Risk

3.

Operational risk
MANAGEMENT

CONTENTS

Classification of
Operational Risk

4.

CASE STUDY

What is Risk?
The definition depends on the context and the purpose for which one wishes to formulate the concept of risk
There are two ways to define risk:
1. Risk is a measure of uncertainty
2. Risk ia a measure to capture the potential of sustaining loss
In discussions of operational risk, the second definition is more appropriate

Definition of
Operational Risk
The risk of loss resulting from inadequate or
failed internal processes, people and systems or
from external events
(Bank for International Settlements (2001b, p.2))
The definition is causal-based providing a
breakdown of operational risk into four
categories based on its sources:
1. Processes
2. People
3. Systems
4. External factors

Operational Risk
Exposure Indicators
The probability of an operational risk event occurring
increases with a larger number of personnel and with a
greater transaction volume

Examples of operational risk exposure indicators:

Gross income
Volume of trades
Value of assets under management

Value of transactions
Number of employees
Employees years of experience
etc.

The Nature of Loss

Internal vs External Operational Risk

CLASSIFICATION OF
OPERATIONAL RISK
Can be classified according to the following

The Impact of Loss

Direct vs Indirect Operational Risk
The Degree of Expectancy
Expected vs Unexpected Operational Risk
Hazard Type, Event Type, and Loss Type
The Severity and Frequency of Loss

The Nature of Loss: Internal vs External Operational Risk

Internal sources include most of the losses caused by human, process,
and technology failures, such as those due to human errors, internal
fraud, unauthorized trading, injuries, business delays due to computer
failures, or telecommunication problems

Internal losses can be prevented with appropriate internal management practices; for
example, tightened controls and management of the personnel can help prevent some
employee errors and internal fraud

External sources include man-made incidents such as

external fraud, theft, computer hacking, terrorist activities,
and natural disasters such as damage to physical assets due
to hurricanes, floods, and fires
External losses are very difficult to prevent. It is possible
to design insurance or other hedging strategies to reduce
externally inflicted losses

The Impact of Loss:

Direct vs Indirect Operational Risk

the losses that directly arise
from the associated events

generally opportunity costs and the losses

associated with the costs of fixing an
operational risk problem

Direct losses
Basel II Capital Accord identifies categories and definitions
of direct operational losses:

Loss Type

Contents

1. Write-downs

Direct reduction in value of assests due to theft, fraud,

unauthorized activity

2. Loss of resource

Payments made to incorrect parties and not recovered

3. Restitution

Cost of compensation paid to clients

4. Legal liability

Judgements, settlements, and other legal cost

5. Regulatory and
compliance

Taxation and fines penalties

6. Loss of assets

Direct reduction in value of physical assests due to accident,

fire, earthquake

Indirect losses
Near-miss losses are the estimated losses from those events that
could potentially occur but were successfully prevented
Latent losses are unrealized losses
Contingent losses are a potential loss that is dependent upon some
future event occurring or not occurring

The Degree of Expectancy:

Expected vs Unexpected Operational Risk

Expected losses are generally those that occur
on a regular basis, such as minor employee
errors and minor credit fraud
Unexpected losses are those losses that
generally cannot be easily foreseen, such as
terrorist attacks, natural disasters, and largescale internal fraud

Hazard type, Event

type, and Loss type

Hazard constitutes one or more factors that increase the probability of

occurrence of an event
Event is a single incident that leads directly to one or more losses
Loss constitutes the amount of financial damage resulting from an event

Hazard potentially leads to events, and events are the cause of loss

The Severity and Frequency of Loss

Loss severity
Low frequency/
High severity

High frequency/
High severity

Low frequency/
Low severity

High frequency/
Low severity
Loss frequency

The losses of high frequency/low severity are relatively unimportant for a company and
can often be prevented
The low frequency/high severity poses the greatest damage. Company must be
particulary attentive to these losses as these cause the greatest financial consequences to
the company, including potential bankcruptcy

OPERATIONAL
RISK
MANAGEMENT
is a continual cyclic process which oversight the
operational risk

Consist of 3 Levels:

In Depth
Deliberate
Time Critical

In Depth
In depth risk management is used
before a project is implemented, when
there is plenty of time to plan and
prepare.
Examples of in depth methods include
Training
Drafting instructions and
requirements
Acquiring personal protective
equipment

Relationship between Risk Management

Principles, Framework and Process
In Depth level of ORM Process
ISO 31000:2009

Deliberate
Deliberate risk management is
used at routine periods through
the implementation of a project or
process.
Examples include
Quality assurance
On-the-job training
Safety briefs
Performance reviews
Safety checks

U.S. Department of Defense summarizes

the deliberate level of ORM process
1.
2.
3.
4.
5.

Identify hazards
Assess hazards
Make risk decisions
Implement controls
Supervise (and watch for changes)

Time Critical
Time critical risk management is used during
operational exercises or execution of tasks. It is
defined as the effective use of all available
resources by individuals, crews, and teams to
safely and effectively accomplish the mission or
task using risk management concepts when time
and resources are limited.
Examples of tools used includes
Execution check-lists
Change management
This requires a high degree of
awareness

situational