Objective:

Background:

Until Basel II reforms to banking supervision, operational risk was a residual category reserved for risks and uncertainties which were difficult to quantify and manage in traditional ways - the "other risks" basket. Such regulations institutionalized operational risk as a category of regulatory and managerial attention and connected operational risk management with good corporate governance.

Two decades (from 1980 to the early 2000s) of globalization and deregulation (e.g. Big Bang (financial markets)), combined with the increased sophistication of financial services around the world, have introduced additional complexities into the activities of banks, insurers and firms in general and therefore their risk profiles.

Since the mid-1990s, the topics of market risk and credit risk have been the subject of much debate and research, with the result that financial institutions have made significant progress in the identification, measurement and management of both these forms of risk. However, the near collapse of the U.S. financial system in September 2008 is an indication that our ability to measure market and credit risk is far from perfect and eventually led to introduction of new regulatory requirements worldwide, including Basel III regulations for banks.

Events such as the September 11 terrorist attacks, rogue trading losses at Society General, Barings, AIB, UBS and National Australia Bank serve to highlight the fact that the scope of risk management extends beyond merely market and credit risk.

These reasons underscore banks' and supervisors' growing focus upon the identification and measurement of operational risk.

The identification and measurement of operational risk is a real and live issue for modern-day banks, particularly since the decision by the Basel Committee on Banking Supervision (BCBS) to introduce a capital charge for this risk as part of the new capital adequacy framework (Basel II).