Operational Risk

Ahraz Sheikh

8.1 INTRODUCTION

The previous three chapters in Part II covered the risks that banks face from business transactions with their customer bases, in the context of either the banking book or the trading book, and how such risks vary with the prevailing economic environment. This chapter covers operational risk, which describes the risks a bank faces as a consequence of executing its business. Such risks reflect the nature of how the bank operates, its internal organisational structure and any vulnerability that could arise as a consequence.

We showed in Chapter 1 that operational risk is a key material risk, potentially exceeding market risk in terms of capital requirements; however, its study and measurement through economic capital modelling and stress testing are only comparatively recent developments. From the 1970s onwards, the Bankers Trust looked into operational risk management and measurement through the pioneering work of Doug Hoffmann (see Hoffmann (2002) for more details), but such studies were uncommon in the banking industry. However, a series of high-profile events in the 1990s, such as the collapse of Baring’s Bank, forced the industry to examine operational risk