The definitions of a number of risks are in the table below.
Operational risk - The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk.
Legal risk - The risk that a transaction proves unenforceable in law or that it has been inadequately documented.
Strategic risk - A business discipline that drives deliberation and action regarding uncertainties and untapped opportunities that affect an organisation’s strategy and strategy execution.
Reputational risk - The risk of negative information about an organisation’s business practices and/or internal controls being generated and exposed.
Market risk - The risk of losses in on and off-balance-sheet positions arising from movements in market prices. The risks subject to this requirement are: The risks pertaining to interest rate related instruments and equities in the trading book Foreign exchange risk and commodities risk throughout the bank.
Credit risk - The risk arising from the possibility of the failure of a borrower to meet the terms of a contractual agreement by defaulting on the payment of interest or the principal.
Liquidity risk - The risk that an organisation may be unable to meet its financial obligations to counterparties.
Interest rate risk - The type of market risk arising from changes in interest rates.
Country risk - The risk arising from unanticipated changes in the economic or political environment in a particular country.
Interrelationship between operational risk and other risks
The risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.
Sub-categories of operational risk
People - Includes: fraud; breaches of employment law; unauthorised activity; loss or lack of key personnel; inadequate training; inadequate supervision. Process - Includes: payment or settlement failures; documentation which is not fit for purpose; errors in valuation/pricing models and processes; project management failures; internal/external reporting; (mis)selling. Systems - Includes: failures during the development and systems implementation process, as well as failures of the system itself; inadequate resources. External events - Includes: external crime; outsourcing (and insourcing) risk; natural and other disasters; regulatory risk; political risk; utilities failures; competition.
The Basel Committee has identified the following types of operational risk events as having the potential to result in substantial losses:-
Internal fraud. For example, intentional misreporting of positions, employee theft, and insider trading on an employee’s own account. External fraud. For example, robbery, forgery, cheque kiting, and damage from computer hacking. Employment practices and workplace safety. For example, workers compensation claims, violation of employee health and safety rules, organised labour activities, discrimination claims, and general liability. Clients, products and business practices. For example, fiduciary breaches, misuse of confidential customer information, improper trading activities on the bank’s account, money laundering, and sale of unauthorised products. Damage to physical assets. For example, terrorism, vandalism, earthquakes, fires and floods. Business disruption and system failures. For example, hardware and software failures, telecommunication problems, and utility outages. Execution, delivery and process management. For example: data entry errors, collateral management failures, incomplete legal documentation, and unauthorized access given to client accounts, non-client counterparty mis-performance, and vendor disputes.
20.4 LOSS SEVERITY AND LOSS FREQUENCY
There are two distributions that are important in...
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