Operational risk

Sergio Scandizzo and Tony Hughes

INTRODUCTION

In line with the provisions of the Basel Accords, operational risk is defined by the European Banking Authority (EBA) as the risk of losses stemming from inadequate or failed internal processes, people and systems or from external events. In this definition, operational risk includes legal risks but excludes reputation risk. Nevertheless, in this chapter we will also cover the impact of climate change on reputation risk, as it is difficult to examine it as detached from a number of potential operational failures (in due diligence, internal controls, stakeholders’ management and so on).

Given that climate risk is articulated along the physical and the policy dimensions, it appears straightforward to consider first direct exposure to physical risk under the “External Events” driver and the regulatory categories of “Damage to Physical Assets”, “Business Disruption and System Failures” and “Employment Practices and Workplace Safety” (Basel Committee on Banking Supervision, 2004). Although those are the event types that we would most directly associate with global warming and extreme weather, we also know that operational risk is procyclical (Allen and Bali, 2007) and largely