A summary of the definitions of risk and risk management, classification of risks, global focus on operational risk, the risk management framework, strategy and process, operational risk management structures and culture. Risk identification and evaluation: procedures, mitigating controls and pilla...
STUDY UNIT 5
OPERATIONAL RISK MANAGEMENT
Risk management and classification of risks
Risk = Uncertainty that an event could cause positive or negative results if it occurs
Measured in terms of impact and likelihood
Risk management = process of managing risk exposures with the objective of preventing a loss event
from occurring or minimizing the e ect should such an event occur.
(An approach to identify, assess and quantify an organisation’s risk exposures originating from
operational, strategic and financial operations)
Classification of risks:
Financial risks: risk exposures that will lead to a direct financial loss & negatively influence the
profitability of the organization.
Non-financial risks: risk exposures that could negatively influence the operations of an
organisation and ultimately incur losses of a quantitative or qualitative nature, indirectly
influencing the profitability business.
Operational risk Risk factors:
Non-financial risks Legal risk People, technology,
Strategic risk regulations, external
Reputational risk factors, processes
Risk categories
Credit risk Risk factors:
Financial risks Market risk Interest rates
Liquidity risk Exchange rates
Enterprise risk management the culture, process and tools to identify strategic opportunities and
reduce uncertainty.
Primary factors that ensure an e ective approach to enterprise risk management
Risk management culture Overall accepted & promulgated approach to risk management in the
organisation
Common risk language Should support an enterprise risk management approach with the aim
of aligning strategies, processes, people and technology
Benefits Organisation has an overview of all the risks it is facing, adequate info
to formulate a realistic risk appetite, sound decision making etc.
Risk reporting Directors get an overview of all the risk exposures & info to make
realistic decisions regarding the risk appetite of the organisation
Financial risks
Credit risk Possibility that the party with whom the organisation is trading may not be able
to fulfil its contractual obligations on/or before the settlement date.
Default risk – costumer is in breach of contract (‘at fault’)
Exposure risk – uncertainty surrounding the payment of agreed-upon future
amounts
Recovery risk – uncertainty surrounding the possibility of recovering
outstanding amounts after customer defaults on payments
Market/price risk Risk of a decrease in the value of a financial portfolio as result of adverse
movement in market variables like prices, exchange rates etc.
2 approaches to measure:
Value-at-risk (VaR) – measurement of risk involved in portfolio of financial
instruments
, Scenario analysis – varying a wider range of parameters at the same time
Market risk also regarded as exposure of an organisation to a potential loss
arising from diminishing sales/margins as a result of changes in market
conditions, outside control of the entity
Interest rate risk Government can increase or decrease the interest rate (repo rate)
Liquidity risk Risk that an organisation may be unable to its financial obligations to
counterparties
Non-financial risks
Strategic risk The risk of making the wrong strategic decisions for the business
Reputational risk Negative exposure of an organisation’s business practices and/or internal
controls that may cause decline in customer base and/or a reduction in revenue
(loss of customers, loss of income, loss of company’s image/branding…)
Examples of reputational risk events: fraud & bribery, poor customer service,
breaches of laws & regulations…)
Operational risk Risk of loss occurring as a result of inadequate systems & controls, human error,
or management failing. (more definition: pg 16-17)
Global focus on operational risk
Basel Committee on Banking Supervision (formulates broad supervisory standards &
guidelines and recommends statements of best practice with the expectation that individual
authorities will take steps to implement them through detailed arrangements.
2 basic principles:
no foreign banking establishment should operate without supervision
supervision should be adequate
King Committee on Corporate Governance
The risk models and framework must provide assurance regarding the following:
E ectiveness & e iciency of operations
Safeguarding of assets
Compliance with applicable laws
Business sustainability
Reliability of reporting
Responsible behavior towards stakeholders
COSO (united states)
Sarbanes-Oxley (united states): section 404 of the Act: General requirements of internal
controls over financial reporting. Rules advocated by this section require that an organisation
provides an internal report that contains assessment by management of the e ectiveness of
the organisation’s internal controls over financial management.
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