Unified Financial Analysis Risk & Finance Lab

1. Unified Financial Analysis Risk & Finance Lab Chapter 12: Operational risk Willi Brammertz / Ioannis Akkizidis

2. Operational risk is special “animal”

3. “Operational” OR Operational Risk

4. Features of the “operational part” of OR • 80% or more of OR systems are concerned with operational part • Operational part = • Work-flow support (reminding people on tasks and controlling it) • In other words: classical management job • To dedicate 80+% on this task makes much sense • Avoiding risk in the operational sphere pays much more than just managing it • Much higher practical relevance of this task than risk management proper which stands on rather shaky theoretical grounds

5. OR and cost • OR is closed to real operation • Basically outside the classical financial part with is main topic of this lecture • OR closely related to the concept of cost as discussed in chapter 7 • OR proper needs dynamic simulation as discussed in part IV

6. OR in practiceDesign Framework Dashboards / Reports GRC – ERM – ICS – ORM QUANTIFICATIONCapital Charge (Basel II AMA, FSA, Solvency II), ERM Risk Measures ACTION MGMT via Plans, Tasks Issues, Risk, Control DATA COLLECTION Risks, LossesEvents, Hazards KEY INDICATORS Risks, Controls Performance ASSESSMENT Risks, Controls, Audit, Processes GLOBAL DATA MANAGEMENTOrg. ▪ Security ▪ Audit ▪ Workflow ▪ Rating ▪ Risk, Process, Product Structures ▪ Interfaces DOCUMENT STORE Procedures, Policies, Guidelines (Management via Action Tracking) Independent Database (J2EE), Independent Hardware Built-in load utilities

7. Example of operational part of OR Risk Manager Unit Manager Employee Identify Risk and define Action Plan and Activity to Mitigate Risk Action Paln Assign Activity to Responsible person Scenario RiskMap Activities to plan Listing of Open Activities Accept and Start performance of Activity. OK Accept or Reject Completion and Monitor Result Confirm Completion when finished with Activity Performance Monitoring Individual Action Item

8. “Risk part” of OR • What cannot be covered by the operational part falls into this category • Techniques applied are partially comparable to market and credit risk, but • Weak statistical basis (each firm is a single case) • Due to the strong relation to cost: needs dynamic simulation technique

9. Relationship between OR and non-life insurance • OR is nothing else than a non-life insurance case • Many OR event types (defined by Basel) are actually insurable • Damage to physical assets • Fire • Natural disaster • … • Theft • … • OR must be controlled via frequency severity (like non-life) • OR needs dynamic analysis to be modeled properly

10. Self insurance and captives • A good way to define the risk part of OR: Self insured non-life risk • Classical OR is covered by the running P&L • Large firms often build captives for self insurance • Captive: Internal insurance company (strictly separated) • Gets all the tax benefits of an insurance company • Examples of captives • Large car producers insure their fleet internally • Large firms have an internal life insurance • …

11. Risk integrationLiquidity as a parallel risk concept

12. Risk integrationValue and liquidity as a parallel concept