Event Risk is Not Your Only Operating Risk
Posted: 7 September 2007 | Source: SunGard
Taking the regulators’ lead, and the lead provided by Pillar 1 in Basel II, many banks have narrowly defined operating risk as “operational event risk,” meaning external threats and failures of processes, systems, and people. Regulators worry about event risks because they often imply that a rule of some sort has been broken, and perhaps also because events such as rogue trading, accounting scandals, and major lawsuits have a grip on the public imagination.
Regulatory concerns are important, but if a bank is pursuing enterprise risk management it must make sure its economic capital program covers all the major risks—and empirical modeling is beginning to reveal that event risk may not be the biggest gap in traditional bank risk modeling. Instead, a more crucial gap is strategic business risk: earnings volatility resulting from factors including a bank’s shrinking market or market share, or competitors forcing down margins. The ERM implications are highlighted in Figure 1, which tracks economic capital allocations by risk type at a typical regional bank. The figure is illustrative, but it is based on a series of client studies.