Trad. vs. Modern Op'al RM
Differences
Risk ID
Trad: all risks (average)
Modern
Define risk universe => exhaustive and mutually exclusive
Use hard or soft data
Risk measures
Trad
Modern
Frequency and severity
Likelihood and impact
Expected loss and unexpected loss
Aggregation
Trad => likelihood can't
Modern => frequency can
Goal
Trad: RM of current threats
Modern: key risks, optimization of risk-reward, risk-control and risk-transfer in a context of cost-benefit analysis
Cost
Trad: resource intensive
Key risks
Modern: much less resource intensive
Key Concepts
Likelihood vs frequency
Expected loss vs unexpected loss
Risk measurement vs assessment
Risk Universe
Trad
Modern
Imprecise classification (financial reporting risk)
Operational risk should be embedded in other risks
No principal-agent risk
Four dimensions
Events
Controllable factors => liquidity risk
Risk factors => beyond control, e.g. interest rate risk
Effects
Factors(frequency) => Events => Factors(severity) => Effects
Risk taxonomy
Modern ORM
Goals (3pts)
Provide framework, tools,infrastructure and methodologies to allow key decision makers to manage operational risks, in conformity with cost-benefit analysis, and within risk tolerance
Ensure transparency in decision making process
Embed a risk culture that harmonizes between decision makers and external stakeholders
In practice
Cost of risk = expected loss + cost of capital * unexpected loss
Strategic risk-control optimization => invest new system
Strategic risk-reward optimization
On risk-adjusted basis
Measurement
Goals
Strategic risk-reward optimization
Analyze principal-agent risk
Strategic risk-control optimization
Estimate reg. and econ. capital
Key metrics
Aggregate expected loss => mean
Aggregate unexpected loss = Total agg. risk exposure - agg. expected loss
N% level total aggregate risk exopsure
Total cost of risk
Actuarial approach
Frequency
Severity
Data
External or internal
Hard or soft