Operational Risk Management (APRM03W) – Exam Paper
Question 1:
Explain the concept of operational risk and differentiate it from market risk and credit
risk.
Answer 1:
Operational risk refers to the risk of loss resulting from inadequate or failed internal
processes, people, systems, or external events. Unlike market risk, which arises from
fluctuations in market prices, or credit risk, which is associated with borrowers failing to
meet obligations, operational risk focuses on internal failures and external disruptions.
Examples include fraud, system outages, human errors, regulatory breaches, and
natural disasters. Operational risk is inherent in all business activities and cannot be
entirely eliminated, only managed and mitigated.
Question 2:
Discuss the key components of an operational risk management framework.
Answer 2:
An operational risk management (ORM) framework typically includes the following
components:
1. Risk Identification: The process of recognizing risks inherent in business
activities. This may involve mapping processes, reviewing historical losses, and
considering potential external events.
2. Risk Assessment and Measurement: Assessing the likelihood and impact of
identified risks, often using qualitative and quantitative approaches, including
scenario analysis and loss data collection.
3. Risk Mitigation: Implementing controls, policies, and procedures to reduce risk
exposure. Examples include internal controls, insurance, system backups, staff
training, and segregation of duties.
4. Monitoring and Reporting: Continuously tracking risk levels and control
effectiveness through key risk indicators (KRIs), dashboards, and internal
reports.
5. Governance and Culture: Establishing clear accountability, policies, and a risk-
aware culture throughout the organization. Senior management should endorse
risk policies and provide oversight.
, The framework ensures systematic identification, assessment, and management of
operational risks while supporting compliance with regulatory requirements such as
Basel II/III.
Question 3:
Illustrate how operational risk can be quantified using both qualitative and quantitative
approaches.
Answer 3:
Qualitative Approaches:
These involve subjective assessments of operational risk, often through interviews, risk
control self-assessments (RCSAs), or expert judgment. For example, a bank may
categorize risks as high, medium, or low based on potential impact and likelihood,
without assigning numeric values. Scenario analysis is another qualitative method
where potential extreme events are evaluated to understand their impact.
Quantitative Approaches:
Quantitative approaches assign numeric values to risk exposure. Common methods
include:
• Loss Distribution Approach (LDA): Uses historical loss data to estimate the
frequency and severity of losses, often assuming statistical distributions to
calculate potential future losses.
• Key Risk Indicators (KRIs): Metrics that provide early warning signals, such as
system downtime hours, number of fraud incidents, or error rates.
• Expected Loss (EL) Calculation: EL = Probability of Loss × Potential Loss
Amount.
By combining qualitative and quantitative methods, organizations achieve a
comprehensive understanding of operational risk.
Question 4:
Examine the role of technology in managing operational risk and highlight potential
technology-related risks.
Answer 4:
Technology plays a dual role in operational risk management. It supports risk
identification, monitoring, reporting, and mitigation. For example, automated risk
dashboards provide real-time data on key risk indicators, while workflow management
systems help ensure process compliance.
Question 1:
Explain the concept of operational risk and differentiate it from market risk and credit
risk.
Answer 1:
Operational risk refers to the risk of loss resulting from inadequate or failed internal
processes, people, systems, or external events. Unlike market risk, which arises from
fluctuations in market prices, or credit risk, which is associated with borrowers failing to
meet obligations, operational risk focuses on internal failures and external disruptions.
Examples include fraud, system outages, human errors, regulatory breaches, and
natural disasters. Operational risk is inherent in all business activities and cannot be
entirely eliminated, only managed and mitigated.
Question 2:
Discuss the key components of an operational risk management framework.
Answer 2:
An operational risk management (ORM) framework typically includes the following
components:
1. Risk Identification: The process of recognizing risks inherent in business
activities. This may involve mapping processes, reviewing historical losses, and
considering potential external events.
2. Risk Assessment and Measurement: Assessing the likelihood and impact of
identified risks, often using qualitative and quantitative approaches, including
scenario analysis and loss data collection.
3. Risk Mitigation: Implementing controls, policies, and procedures to reduce risk
exposure. Examples include internal controls, insurance, system backups, staff
training, and segregation of duties.
4. Monitoring and Reporting: Continuously tracking risk levels and control
effectiveness through key risk indicators (KRIs), dashboards, and internal
reports.
5. Governance and Culture: Establishing clear accountability, policies, and a risk-
aware culture throughout the organization. Senior management should endorse
risk policies and provide oversight.
, The framework ensures systematic identification, assessment, and management of
operational risks while supporting compliance with regulatory requirements such as
Basel II/III.
Question 3:
Illustrate how operational risk can be quantified using both qualitative and quantitative
approaches.
Answer 3:
Qualitative Approaches:
These involve subjective assessments of operational risk, often through interviews, risk
control self-assessments (RCSAs), or expert judgment. For example, a bank may
categorize risks as high, medium, or low based on potential impact and likelihood,
without assigning numeric values. Scenario analysis is another qualitative method
where potential extreme events are evaluated to understand their impact.
Quantitative Approaches:
Quantitative approaches assign numeric values to risk exposure. Common methods
include:
• Loss Distribution Approach (LDA): Uses historical loss data to estimate the
frequency and severity of losses, often assuming statistical distributions to
calculate potential future losses.
• Key Risk Indicators (KRIs): Metrics that provide early warning signals, such as
system downtime hours, number of fraud incidents, or error rates.
• Expected Loss (EL) Calculation: EL = Probability of Loss × Potential Loss
Amount.
By combining qualitative and quantitative methods, organizations achieve a
comprehensive understanding of operational risk.
Question 4:
Examine the role of technology in managing operational risk and highlight potential
technology-related risks.
Answer 4:
Technology plays a dual role in operational risk management. It supports risk
identification, monitoring, reporting, and mitigation. For example, automated risk
dashboards provide real-time data on key risk indicators, while workflow management
systems help ensure process compliance.
