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CHAPTER 7 OPERATIONAL RISK - Coggle Diagram
CHAPTER 7
OPERATIONAL RISK
DEFINITION AND CONCEPT
Defined as a risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events.
IMPORTANCE OF OPERATIONAL RISK
Reduction of operational loss.
Lower compliance / auditing costs.
Early detection of unlawful activities.
Reduced exposure to future risks.
SOURCES OF OPERATIONAL RISK
Technological (technological failure and deteriorating systems)
Employees (human error and internal fraud)
Customer relationship (contractual disputes)
Capital assets (destruction by fire or other catastrophes)
External fraud.
EXAMPLE OF OPERATIONAL RISK
BERNIE MADOFF
lost $65 billion in client funds as part of a giant Ponzi scheme.
He pledge guilty to 11 felony counts of fraud in the operations of his hedge fund business. Madoff Investment securities.
Madoff was sentenced to 150 years in prison with restitution of $170 billion.
BARCLAY BANK
Happen in between 2005 to 2009, where the bank manipulated and made false concerning the LIBOR to benefit its derivatives trading positions.
The bank make false LIBOR reports at the direction of members of senior management to protect its reputation during global financial crisis.
Barclay's traders also ask other banks to assist in manipulating teh global benchmark interest rate.
Barclays ordered to pay $455 million fines, cease and desist from further violation as charged.
Senior executives and traders involved with manipulation resigned or suspended.
IDENTIFYING OPERATIONAL RISK
Internal risk + External risk = Categories operational risk
APPROACH IN ASSESSING OPERATIONAL RISK
COMPARISON APPROACH
Top-down models
Attempt to measure operational risk at the broadest level using firmwide or industry wide data.
Bottom-up models
Start at individual business unit or process level.
The result then aggregated to determine the risk profile of the institutions.
MANAGING OEPRATIONAL RISKS
1. Capital Allocation and Insurance
Expected loss (EL)
The size of operational losses expected to occur
High frequency, low severity.
Unexpected loss (UL)
Deviation between the quantile loss at some confidence level and expected loss.
Lower frequency, high severity event.
Stress loss
Losses are very infrequent but extremely damaging to the institution
2. Mitigating Operational Risk
Operational risk can minimized in a number of ways through:
Internal
Separation of functions
Dual entries
Reconciliation.
Tickler systems
Controls over ammendments
External
Confirmations
Verification of prices
Authorization
Settlement
Internal and external audits
3. Conceptual Issues
1st operational risk is largely internal to financial institutions
2nd Operational risk is not easy to measured and control.
3rd large operational losses that can threaten the stability of a situation are relatively rare.
CONCLUSION
In controlling operational risk
Loss prevention: training, development, review of employees.
Loss control: planning, organization, back-up
Loss financing: external insurance
Loss insulation: financial institution capital