1. © Brammertz Consulting, 20091Date: 20.09.2015 Unified Financial Analysis Risk & Finance Lab Chapter 12: Operational risk Willi Brammertz / Ioannis Akkizidis

2. © Brammertz Consulting, 20092Date: 20.09.2015 Operational risk is special “animal”

3. © Brammertz Consulting, 20093Date: 20.09.2015 “Operational” OR Operational Risk

4. © Brammertz Consulting, 20094Date: 20.09.2015 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. © Brammertz Consulting, 20095Date: 20.09.2015 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. © Brammertz Consulting, 20096Date: 20.09.2015 OR in practice Design Framework GLOBAL DATA MANAGEMENT Org. ▪ Security ▪ Audit ▪ Workflow ▪ Rating ▪ Risk, Process, Product Structures ▪ Interfaces Dashboards / Reports GRC – ERM – ICS – ORM Dashboards / Reports GRC – ERM – ICS – ORM Independent Database (J2EE), Independent Hardware DATA COLLECTION Risks, Losses Events, Hazards DATA COLLECTION Risks, Losses Events, Hazards QUANTIFICATION Capital Charge (Basel II AMA, FSA, Solvency II), ERM Risk Measures ASSESSMENT Risks, Controls, Audit, Processes ASSESSMENT Risks, Controls, Audit, Processes KEY INDICATORS Risks, Controls Performance KEY INDICATORS Risks, Controls Performance ACTION MGMT via Plans, Tasks Issues, Risk, Control ACTION MGMT via Plans, Tasks Issues, Risk, Control DOCUMENT STORE Procedures, Policies, Guidelines (Management via Action Tracking) DOCUMENT STORE Procedures, Policies, Guidelines (Management via Action Tracking) Built-in load utilities

7. © Brammertz Consulting, 20097Date: 20.09.2015 Example of operational part of OR 20 September 201520 September 2015, Slide 7 Unit ManagerEmployee Identify Risk and define Action Plan and Activity to Mitigate Risk Assign Activity to Responsible person Scenario RiskMap Action Paln Activities to plan Listing of Open Activities Accept and Start performance of Activity. Individual Action Item Confirm Completion when finished with Activity Performance Monitoring Accept or Reject Completion and Monitor Result OK Risk Manager

8. © Brammertz Consulting, 20098Date: 20.09.2015 “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. © Brammertz Consulting, 20099Date: 20.09.2015 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. © Brammertz Consulting, 200910Date: 20.09.2015 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. © Brammertz Consulting, 200911Date: 20.09.2015 Risk integration Liquidity as a parallel risk concept 11

12. © Brammertz Consulting, 200912Date: 20.09.2015 Risk integration Value and liquidity as a parallel concept 12