lecture 2 - operational risk management Flashcards
what are operational risks?
They represent losses arising from lapses of internal control, human errors and failures to adequately manage external events like downturns and tech developments
why is the choice of risk metric important?
failure to use the appropriate risk metric leads to operational risk, measures like VaR are appropriate for market portfolios but not so much for property as the horizons don’t match, leading to incorrect estimates and halting risk mgment ability.
why might known risks be ignored?
‘too good to be true’ results - means risks will be ignored as long as big bonuses are being realised
how was the subprime crisis an example of operational risk?
shows dangers of incorrectly measuring known risks - mortgage default risks were well known, but the frequency and scale of the risk was grossly underestimated
what do known unknowns show in terms of risk?
a failure to identify and measure unknown risks.
how can communication failures lead to operational risk?
upwards reporting may be slow, incomplete or distorted and result in boardroom inaction
how do weak non-execs create operational risk?
can lead to monitoring and management lapses, especially if they don’t understand business properly.
how have financial firms responded to operational risk?
heavily trust-based financial firms now have to hold regulatory capital to mitigate operational risks and prevent reputational damage
what is the audit-related response to risk?
internal and external audit risk assessments are important for IT dependent and opaque financial firms.
also, recently have seen an increased incidence/scope of line mgment audits. not just looking at financials but management aspects too like reporting systems and evaluation of risks.
how can insurance help with operational risk?
can be used for cyber breaches, business disruption etc.
what can operational control systems bring to a company?
maintaining financial stability, successfully effecting internal/external changes, safeguarding assets, ensuring compliance with regs and laws, facilitating true and fair accounting of transactions
what is the key to an effective operational control system?
a flexible mix of control mechanisms!
control mechanisms:
controls over input, e.g. HR
controls over processes, systems/procedures/policies. place for mgment and financial accounting to assist, e.g. with audits and inspection schemes to assist corp governance.
controls over output, e.g. financial and non-financial measures. need control over confidential outputs
qualitative approaches - surveys, focus groups, market research
what does an effective operational control system need to produce useful results?
measurement against a standard or target:
target must be meaningful. also need a method of gathering relevant data and info and of comparing this info to the standard. also a means of initiating effective control.
what are the assumptions of measuring against a target/standard?
assumed that we know:
what we want to know
how to measure it
target to set for it
how to make comparisons
that we can take appropriate corrective action
what are the 5 main standards against which performance can be compared?
previous time period
similar organisations
estimates of future org’s performance (ex-ante)
estimates on what might have been achieved (ex-post)
performance necessary to achieve defined goals - growth/performance/output etc
