The financial industry has developed standard methods to measure and manage market and credit risks. The industry is turning next to operational risk, which has proved to be an important cause of financial losses. Indeed, most company-specific financial disasters can be attributed to a combination of market and credit risk along with some failure of controls, which is a form of operational risk.
As in the case of market and credit risk, the financial industry is being pushed in the direction of better control of operational risk by bank regulators. For the first time, the Basel Committee on Banking Supervision has established capital charges for operational risk, in exchange for lowering them on market and credit risk. This new charge would constitute approximately 12% of the total capital requirement.1 As a result, this is forcing the banking industry to pay close attention to operational risk.
As with market and credit risk, the management of operational risk follows a sequence of logical steps:
3. monitoring, and
4. control or mitigation.
Historically, operational risk has been managed by internal control mechanisms within business lines, supplemented by the audit function. The industry is now starting to use specific structures and control processes specifically tailored to operational risk.
To introduce operational risk, Section 25.1 summarizes lessons from well-known financial disasters. Given this information, ...