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P2.T7.600. Operational risk event risk categories (Cruz, Peters and Shevchenko)

Nicole Seaman

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Learning outcome: Describe the seven Basel II event risk categories and identify examples of operational risk events in each category.

Please note that the Bank for International Settlement (BIS) is proposing a single, simplified method for the estimation of operational risk capital called the Standardized Measurement Approach (SMA), see http://www.bis.org/bcbs/publ/d355.htm released in March 2016.

Questions:

600.1. Trader Ben Smith enters a foreign exchange (FX) spot transaction, buying euros for dollars. He then quickly enters another transaction selling euros for dollars. He makes a quick profit from these two transactions, however due to confusion in the back office, settlement to the counterparty is delayed to four days later. The counterparty demands compensation for the delayed settlement and the claim includes lost (forgone) interest. The cost of the mistake exceeds the profit on the trade, resulting in an operational loss. To which Level 1 event risk category should this loss be assigned?

a. Improper Business or Market Practices
b. Business Disruption and System failures
c. Clients, Products, and Business Practices
d. Execution, Delivery & Process Management


600.2. An Investment Advisor at a division of an international bank was sued by a employer-based retirement plan sponsor for fiduciary breach. The client claimed that the Advisor's recommendation put the Advisor intention to earn a commission and the firm's profit motive above the client's best interest. The lawsuit was settled. To which event risk category should this loss be assigned?

a. Improper Business or Market Practices
b. Business Disruption and System failures
c. Clients, Products, and Business Practices
d. None of the above, legal risk is not an operational risk


600.3. Last year, Goodholdings Bank released a major upgrade of its custom-built enterprise resource planning (ERP) software platform. However, the release exposed problems with the extant codebase. Consultants were hired to re-factor the code and resolve the so-called technical debt. Technical debt is the development effort required to fix structural software problems that remain in code due to sub-optimal programming practices; for example, a quick-fix might satisfy an immediate user requirement but interfere with long-term compatibility or performance. Management views the cost of hiring the consultants as an operational loss. To which event risk category should the loss be assigned?

a. Internal fraud
b. Business disruption and system failures
c. Employment Practices and Workplace Safety
d. None of the above, technical debt is an exception that is excluded from the taxonomy

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