Fundamentals of Risk Management

Measurement of operational risk
Operational risk has become a specific issue in financial institutions, because of the 
requirement to measure/quantify the level of operational risk that they face. The 
measurement of operational risk can involve a number of methods and these are 
normally based on historical information, simulated information or a combination 
of these. Table 30.2 sets out examples of operational risks faced by a bank or finan-
cial institution.
Basel II offers three alternative approaches to measuring operational risk for
regulatory capital purposes, as set out below. The first two methods are a proxy for 
operational risk management exposure; whilst research work was undertaken to 
validate these methods, individual firms could vary substantially from the assess-
ments these two methods would provide:
●
●
Basic indicator approach: calculates the value of operational risk capital 
using a single indicator for the overall risk exposure.
●
●
Standardized approach: calculates the value for operational risk, using
a broad financial indicator, multiplied by operational loss experience.
●
●
Advanced approach: uses the internal loss data and a combination of 
qualitative and quantitative methods to calculate the operational risk
capital.
In order to measure operational risk, the financial institution needs to adopt a
structured approach. Even after the identification of the risks, quantification is only 
possible if the amount of damage and risk probabilities are determined. Operational 

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operational risk management
365
event 
category
Definition
Description
examples
Internal fraud Losses due to 
fraud, 
misappropriation or 
circumvention of 
regulations by 
internal party
Unauthorized 
activity, theft and 
fraud
Unreported transactions
Unauthorized transactions
Theft and fraud
Tax non-compliance
Insider trading
External 
fraud
Losses due to fraud, 
misappropriation or 
circumvention of 
the regulations by 
third party
Systems security, 
theft and fraud
Theft/robbery
Forgery
Hacking/theft of 
information
Employees
Losses arising from 
injury or non-
compliance with 
the employment 
legislation
In a safe 
environment, 
damaged 
employee relations 
and discrimination
Compensation claim
Discrimination allegation
Clients
Losses arising from 
failure to meet 
professional 
obligations to 
clients
Disclosure and 
fiduciary
Fiduciary breaches
Disclosure violations
Misuse of confidential 
information
Physical 
assets
Losses arising from 
loss or damage to 
physical assets
Disasters and 
other events
Natural disaster losses
Terrorism/vandalism
Systems
Losses arising from 
disruption of 
business or system 
failures
Systems
Hardware or software 
failure
Telecommunications
Utility disruption
Processes
Losses from failed 
transaction 
processing or 
process 
management
Transaction 
capture, execution, 
documentation 
and maintenance
Data entry, or loading error
Missed deadline or 
responsibility
Failed reporting obligation
Incorrect records