11_operational_riskeconomic_capital

11_operational_riskeconomic_capital - OPERATIONAL RISK...

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OPERATIONAL RISK & ECONOMIC CAPITAL J. Wei, Department of Management, U of T 1 MGTD78 Definition of operational risk Types of operational risks Measuring operational risk Regulatory capital under Basel II Definition of economic capital Economic capital – parameters and calculations Typical loss distributions Aggregating economic capital
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OPERATIONAL RISK DEFINED J. Wei, Department of Management, U of T 2 MGTD78 Definition: Operational risk is the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events Basel Committee Jan 2001 Scope: all risks other than market and credit risks – too broad risks associated with operations – too narrow Basel Committee definition includes people risks, technology and processing risks, physical risks, legal risks, etc Exclusion: reputation risk and strategic risk
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TYPES OF OPERATIONAL RISK J. Wei, Department of Management, U of T 3 MGTD78 Categorization: Internal fraud (IF) External fraud (EF) Employment practices and workplace safety (EPWS) Clients, products and business practices (CPBP) Damage to physical assets (DPA) Business disruption and system failures (BDSF) Execution, delivery and process management (EDPM) Internal fraud (IF): Scope: employee theft, misreporting of positions, rogue trading, etc Example: Allied Irish Bank ($700m), Barings ($1b), Daiwa ($1.4b), and Societe Generale's ( 4.9b) Feature: SG (€4.9b, 2008). Jerome Kerviel: 31 years old, racked 1,071 bogus trades worth €50 billion on index futures. Largest fraud in banking history.
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TYPES OF OPERATIONAL RISK J. Wei, Department of Management, U of T 4 MGTD78 External fraud (EF): Scope: robbery, computer hacking, etc Example: Republic New York Corp, aided fraud by a client, lost $611 million (2001) Feature: Martin Armstrong (commodity trader), client of Republic NY. RNY conspires with Armstrong who bilked 139 Japanese investors for about $700 million (through a Ponzi scheme involving futures trading). RNY plead guilty and paid $606 million in restitution. Employment practices and workplace safety (EPWS): Scope: discrimination, violation of rules Example: Around 1,000 women launched group lawsuit against Merrill in 1999 for gender discrimination. Merrill paid $100 million in settlements. Grew to $250m later due to more settlements Feature: Stephanie Villalba, former head of Merrill’s European private client business. Complaint: boss asked her to sit in a
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TYPES OF OPERATIONAL RISK J. Wei, Department of Management, U of T 5 MGTD78 Clients, products and business practices (CPBP): Scope: Improper selling, money laundering, etc Example: Household International lost $484 million for improper lending (2002); Providian Financial Corp. lost $405 million for improper sales and billing practices Feature: Household Int’l. One of the largest consumer-finance
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This note was uploaded on 05/10/2011 for the course MGT D78 taught by Professor Wei during the Spring '11 term at University of Toronto- Toronto.

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11_operational_riskeconomic_capital - OPERATIONAL RISK...

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