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Operational Risk Management


Operational risk management has evolved over the last decade into one of the most important functions in banks and financial institutions. Failure to manage operational risks has pushed banks to the brink of collapse time and again and led some into bankruptcy. In the wake of the global financial crisis, managing operational risk has taken on an added importance.

An effective strategy to control operational risks spans the entire operation of a bank, from the front line tellers who deal with customers day in and day out, all the way through the rank of senior managers and to the board of directors, which is ultimately responsible. Banks and banking professionals must be fully versed in the practice of operational risk management and take an approach to risk that helps minimize exposure and maximize risk coverage.

Operational Risk Management by the Hong Kong Institute of Bankers (HKIB) explores the evolution of ORM. It considers risk factors and ways to track them and minimize their impact. It looks at how to develop strategies and frameworks to manage operational risk and delves into how regulators view the practice of operational risk management as well as the discipline they place on banks to limit their exposure.

Topics covered in this book include:

  • Risk factors and control methods
  • Operational risk management frameworks
  • Case studies of ORM failures
  • Operational risk planning
  • Risk measurement and assessment
  • Basel II accord on operational risk management
  • Regulatory approaches to ORM

With over a century of history, Bank of Communications Co., Ltd. is always in pursuit of excellence. We endeavor to create value for all stakeholders while contributing to the sustainable development of the economy, society and the environment. Our sponsorship to this publication denotes our commitment to professionalism in the banking and financial industries.

With an extensive network in Hong Kong and a dedicated team of professionals, Bank of Communications Co., Ltd Hong Kong Branch strives to realize the personal goals of clients with integrated wealth management strengths and expertise in RMB services.

Preface ix


1 Overview and Definition 3

Learning Objectives 3

Introduction 4

What is Operational Risk? 4

Important Operational Risk Events 8

Distinguished From Other Risks 13

Distinguished From Operations Risk 17

Boundaries of Operational Risk 19

Drivers of Operational Risk Management 20

Integrating Related Disciplines 21

Summary 23

Key Terms 24

Study Guide 24

Further Reading 25

2 Operational Risk Management Frameworks 27

Learning Objectives 27

Introduction 28

Operational Risk Management Frameworks 28

ORM Frameworks and Goals 32

Summary 34

Key Terms 35

Study Guide 35

Further Reading 36

3 Case Studies 37

Learning Objectives 37

Introduction 38

Categories of Operational Risk 38

Lessons in ORM 58

Summary 60

Key Terms 60

Study Guide 61

Further Reading 61


4 Methods and Tools 65

Learning Objectives 65

Introduction 66

The ORM Process 66

Managing Operational Risk 76

Summary 80

Key Terms 82

Study Guide 82

Further Reading 83

5 Risk Identification 85

Learning Objectives 85

Introduction 86

Assessing Risk 87

Categorising Risk 90

Summary 96

Key Terms 97

Study Guide 97

Further Reading 98

6 Risk Measurement and Assessment 99

Learning Objectives 99

Introduction 100

Impact and Probability 101

Value-at-Risk 109

Loss and Capital Charge 111

Summary 115

Key Terms 116

Study Guide 117

Further Reading 117


7 Risk Control and Mitigation 121

Learning Objectives 121

Introduction 122

Incident Management 122

Assumptions, Avoidance and Transference 126

Insurance 129

Internal Controls 132

Contingency Planning 134

Summary 135

Key Terms 136

Study Guide 137

Further Reading 137

8 Risk Reporting 139

Learning Objectives 139

Introduction 140

Risk Profile 140

Reporting 142

Incidents and Data Reporting 147

Summary 149

Key Terms 150

Study Guide 151

Further Reading 151

9 Related Techniques 153

Learning Objectives 153

Introduction 154

Scenario Analysis 154

Stress Testing 155

Operational Risk Models 159

Summary 169

Key Terms 170

Study Guide 170

Further Reading 170


10 Regulatory Requirements 175

Learning Objectives 175

Introduction 176

Basel II 176

Basel III 179

HKMA Risk-Based Supervisory Approach 182

Approaches to Assessment 186

Basel III Risk Exposures 190

Summary 193

Key Terms 194

Study Guide 195

Further Reading 195

11 Risk Governance 197

Learning Objectives 197

Introduction 198

Risk Governance Structure 199

Other Considerations 207

RCSA, KRIs, and Risk Events 209

Summary 211

Key Terms 212

Study Guide 213

Further Reading 213

Index 215