Managing Operational Risk
First published:
ISBN: 9781782722861
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Aligning Operational Risk Management Frameworks to Appetites
Introduction
Three Historical Spikes in Operational Risk Losses
First-Order Effects: Transforming Credit Defaults and Market Turmoil into Operational Risk Losses
Second-Order Effects: Transforming Rising Unemployment and Falling Interest Rates into Operational Risk Losses
Conclusions and Root Causes
Regulatory Change: Part of a Perfect Storm
Macroeconomic Threats: Tax, Rising Interest Rates and New Asset Bubbles
New Technology: Changing Business Models and Risk Profiles
Three Horsemen: Societal, Political and Environmental Change
Backtesting to the Mid-1990s and Conclusions
Defining and Cascading Operational Risk Appetites
Aligning Operational Risk Management Frameworks to Appetites
Estimating Exposures to Tail Events
Solutions for a Triumvirate of Seemingly Intractable Problems
Conclusions
“You don’t get any credit for disaster averted.”
Hank Paulson, Secretary of the US Treasury, 2006–9
Operational risk is categorised by Basel II into a series of events. These events are synonymous with risk, as a risk is the potential for an event to occur that has the potential for an adverse impact.11“Risk can be defined as the combination of the probability of an event and its consequences” (ISO/IEC Guide). There are a range of causes that increase the likelihood of an event, and also a variety of financial and nonfinancial impacts.
Operational risk managers have developed a portfolio of tools to manage operational risk that are focused on understanding the firm’s profile, ie, causes, preventative, detective and mitigating controls, events/risks, and financial and nonfinancial impacts. This is illustrated in the “butterfly” diagram in Figure 11.1.
Tailoring these tools in line with a firm’s appetite for operational risk is very challenging because of the near-infinite complexity of the relationship between causes, controls and risks. Consequently, it has to be based on experience and judgement, and requires board-level engagement and
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