Operational Risk Management System in an Enterprise Risk Framework
Assume that you are the Operational Risk Manager of a large financial institution where you report to the Chief Risk Officer (CRO). The CRO is responsible to manage the enterprise risk at the corporate level that includes all significant risks of the firm including but not limited to financial (i.e., market, credit, interest rate); strategic; operational and reputational risks. In the past, the firm measured operational risk using Value at Risk (VaR) technique that is frequently used to quantify market and credit risk. However, the CRO is not comfortable with the use of VaR in quantifying operational risk of the firm.
She argues that operational risk is fundamentally different from financial risk and that managerial judgments in business decision making relevant to operational risk cannot be replaced by quantitative risk models. In her understanding a significant part of operational risk management involves the management of people, process and system, where individual biases and associated subjectivity play dominant role. She comments that “the current industry practice of managing operational risk takes the objective view of a subjective problem”. With this understanding she is determined to change the culture of the organisation in conceptualising and managing operational risk associated with the business.
For the purpose of this coursework you are required to do the following;
1. Use the hypothetical operational loss data on GCULearn to demonstrate how operational risk capital is quantified in practice and calculate the following:
A. The bank’s Value at Risk (VaR)
B. The bank’s Expected Loss (EL) and
C. The capital charge.
2. Assume that the operational loss series follows a Poisson distribution and the loss severity series follows a lognormal distribution.
3. Write a report to explain your views on the quantification and management of operational risk that could help the CRO in managing operational risk under the wider focus of Enterprise Risk Management (ERM).
Your report must in addition to other factors address the following;
➢ A critical analysis of the characteristics of operational risk with other types of risk in a typical financial institution,
➢ A discussion of the strengths and weakness of the output of your quantification exercise that contributes in the decision making of the business in relation to operational risk,
➢ The importance of creating a risk culture that reflects the behaviour of a financial institution toward risk-taking in Operational Risk Management (ORM), and
➢ Role of Operational Risk Management (ORM) in an Enterprise Risk Management (ERM) Framework, amongst others.
An important element of this course work is the ability to critically appraise the literature and theory gained from variety of sources, developing own ideas in the process. You should conduct extensive literature search to gain a comprehensive and detailed knowledge of key issues in operational risk management.
This coursework should be written in a report format. A well written report will demonstrate your ability to:
• Understand the aim(s) and objective(s) of the report and adhere to its specifications;
• Gather, evaluate and analyse relevant information;
• Structure material in a coherent and logical manner;
• Make correct conclusions that are supported by the evidence and analyses of the report;
• Make practical recommendations where necessary.
The report should have the following features:
Title page
Terms of reference
Summary (Abstract)
Table of contents
Introduction
Methods
Results (include the results from the OpRisk quantification exercise with any necessary diagrams, graphs or tables that support your results).
Discussion
Conclusion
References
