RSK4801+Assignment+01+Suggested+solutions

Suggested Solutions Assignment 01 Operational Risk Management

RSK 4801

Department of Finance, Risk Management and Banking This tutorial letter contains important information about your module.

You have been appointed since the beginning of January as the Operational Risk Manager for Benchmark Bank. In your first discussion with the Chief Risk Officer (CRO), she raised a concern that the risks are not properly classified by the business units and that she is uncomfortable with the accuracy of the loss reporting.

The CRO specifically requested you to analyse the reported losses and where necessary, correct the information to reflect the losses more accurately for the annual report. You obtained the current Loss Register and noticed that it is in a dire state. You decided to correct the Loss Register by following the following steps in a table format: 

Classify the losses according to the main risk types



Classify operational risk losses according to the operational risk sub-types



Convert foreign currency into South African Rand



Add the amounts to determine the frequency and total loss per risk category

Answer The purpose of this assignment was to give students the opportunity to classify risks in terms of the risk definitions and to demonstrate how difficult it sometimes is to classify risks, as the consequence of the event can caused by a number of different factors. In practice, this is known as the boundary effect.

Although it may appear to be trivial, the impact on the profitability of a department or division can be impacted significantly due to loss events. Banks also have to calculate regulatory capital and for operational risk capital, loss experience is one of the factors considered to calculate the capital. The incorrect classification of risk can therefore have a significant impact on a department or division, both from a profitability and regulatory capital aspect. Below is the suggested solution for the classification of the events. We added an explanation where there is a boundary effect. Work through the examples and ensure that you understand the reasoning for the classification.

LOSS REGISTER: BENCHMARK BANK FOR THE YEAR ENDED 2014

DESCRIPTION Trader on the FX desk processed the transaction as buy instead of sell AML function wrong directional view on interest rates. Loss on swap curve.

Bond options trader captured expiry date wrong SAFEX penalty for late margin calls. Clearing House official did not contact broker for payment.

CREDIT

MARKET PEOPLE Operational risk, People

Market risk

OPERATIONAL RISK PROCESS SYSTEMS

EXPLANATION EXTERNAL Finger trouble by a trader

The bank took a wrong view on interest rates and positioned the book of the bank accordingly and the lost was caused by the change in interest rates. Operational risk, People

Operational risk, People

The official was negligent by not contacting the broker for payment.

JSE penalty for late bond settlements. Missed settlement window due to offshore counterparty processing transaction late. Customer claim for bad derivatives investment advice Interest on late Citi Bank collateral calls. Incorrect calculation by clerk Duplicate payment to Lloyds Bank

Payment to Sumitomo into wrong act loss was ¥156312 due to change in 4

Operational risk, Process

Operational risk, People

Operational risk, People

Operational risk, People

Operational risk, People

Although the amount of the loss was influenced by the change of the currency, the underlying cause was the incorrect payment.

RSK4801 currency

Payment fraud by Triad syndicate JSE penalty for late settlements. Recon outstanding for cleared funds. Goodwill payment to Big Shot Ltd because business online was down over month end Fraud due to sharing of passwords by payment staff Teller difference

Operational risk, External Operational risk, Process

Operational risk, Systems

Operational risk, People

Operational risk, People

Teller difference

Operational risk, People

Teller difference

Operational risk, People

Teller difference new teller

Operational risk, People

Polokwane branch

Operational risk, People

5

Staff fraud

Operational risk, People

Fraudulent payment by staff member Cash centre

Operational risk, People

BA 800 submitted incorrectly

Operational risk, People

Teller difference

Operational risk, People

Teller difference

Operational risk, People

Stolen cheque book Bob Mugabe Loaded incorrect ATM fee increases for July - EXCO decided not to backdate increases for sensitivity to reputational risk Staff fraud

Operational risk, External

Operational risk, External Operational risk, People

Operational risk, People

Lost guarantee P Pompies BA 800 submitted incorrectly (Jun)

6

Operational risk, Process Operational risk, People

RSK4801 Irrecoverable losses due to not follow up of excess reports Bad debt written off: JMM Construction Bad debt written off: BC Construction Supplies Access payment for motor car accident claim Access payment for motor car accident claim Access payment for motor car accident claim Late registration of bonds due to strike penalties/interest claims to customers Staff fraud

Operational risk, People

Credit risk

Credit risk

Operational risk, People Operational risk, People Operational risk, People Operational risk, People

Operational risk, People

Staff fraud

Operational risk, People

Teller difference

Operational risk, People

7

Teller difference

Operational risk, People

Interest claim by client because of bad service (customer not informed of change in interest rates) Commodities trader captured incorrect amount Write off due to incorrect model parameters on 5 year CDO Embossing fraud - card cloned CR

Operational risk, People

Operational risk, People Operational risk, Process

Operational risk, External

Charge back recon differences

Operational risk, Process

Interest claim due to late SWIFT transfer Processing official used incorrect rate Damage to premises due to ATM bombings (consolidated) ATM bombings (money stolen)

Operational risk, People

Branch teller differences

Operational risk, People

8

Operational risk, People Operational risk, External

Operational risk, External

RSK4801

You needed to convert the foreign exchange in the loss register to South African Rand.

To convert American Dollar (USD) to rand, multiply the dollar amount with the exchange rate e.g. $1000 x 7.11789 = R7 117.89. You can use the same principle for the other currencies.

DESCRIPTION

CREDIT

MARKET PEOPLE

Trader on the FX desk processed the transaction as buy instead of sell AML function wrong directional view on interest rates. Loss on swap curve. Bond options trader captured expiry date wrong

OPERATIONAL RISK PROCESS SYSTEMS

EXTERNAL

R236,423.89

R1,573,035.00

R948,672.54

SAFEX penalty for late margin calls. Clearing House official did not contact broker for payment. JSE penaly for late bond settlements. Missed settlement window due to offshore counterparty processing transaction late. customer cliam for bad derivatives investment advice

R100,000.00

interest on late Citi Bank collateral calls. Incorrect calculation by clerk

R387,562.00

R150,000.00

R150,000.00

9

DESCRIPTION

CREDIT

MARKET PEOPLE

duplicate payment to Lloyds Bank

R362,684.00

payement to Sumitomo into wrong act loss was ¥156312 due to change in currency payment fraud by triade syndicate

R17,679.31

JSE penalty for late settlements. Recon oustanding for cleared funds. goodwill paymt to Big Shot Ltd becuase business online was down over month end fraud due to sharing of passwords by payment staff

EXTERNAL

R6,500,000.00 R450,000.00

R600,000.00

R300,000.00

teller difference

R15,687.00

teller difference

R5,962.00

teller difference

R1,114.00

teller difference - new teller

R214,509.00

polokwane branch

R100,250.00

staff fraud

R56,000.00

fruadulent payment by staff member

R30,000.00

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OPERATIONAL RISK PROCESS SYSTEMS

RSK4801 DESCRIPTION

CREDIT

MARKET PEOPLE

OPERATIONAL RISK PROCESS SYSTEMS

R5,000.00

BA 800 submitted incorrectly teller difference

R32,418.00

teller difference

R35,167.00 R10,000.00

Stolen cheque book Bob Mugabe R235,145.00

Loaded incorrect ATM fee increases for July - EXCO decided not to backdate increases for sensitivity to reputational risk staff fraud

R342,190.00 R500,000.00

Lost guarantee P Pompies R10,000.00

BA 800 submitted incorrectly (Jun)

R753,451.00

Irrecoverable losses due to not follow up of excess reports Bad debt written off: JMM Construction Bad debt written off: BC Construction Supplies Access payment for motor car accident claim

EXTERNAL R15,600,000.00

cash centre

R2,567,000.00 R654,789.00 R5,000.00

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DESCRIPTION

CREDIT

MARKET PEOPLE

Access payment for motor car accident claim

R5,000.00

Access payment for motor car accident claim

R5,000.00

Late registration of bonds due to strike - penalties/interest claims to customers staff fraud

OPERATIONAL RISK PROCESS SYSTEMS

R105,678.00

R10,300.00

staff fraud

R53,800.00

teller difference

R23,749.00

teller difference

R43,671.00

interest claim by client because of bad service (customer not informed of change in interest rates) commodities trader captured incorrect amount

R73,421.00

R493,598.96 R150,000.00

write off due to incorrect model parameters on 5 year CDO

R15,000.00

Embossing fraud - card cloned CR R256,896.00

Charge back recon differences Interest claim due to late SWIFT transfer 12

EXTERNAL

R15,352.00

RSK4801 DESCRIPTION

CREDIT

MARKET

OPERATIONAL RISK PROCESS SYSTEMS

PEOPLE

EXTERNAL

R12,180.52

Processing official used incorrect rate damage to premises due to atm bombings (consolidated)

R7,000,000.00

ATM bombings (money stolen)

R11,890,650.00 R165,631.00

branch teller differences TOTAL PER CATEGORY NUMBER OF EVENTS

R3,221,789.00

R1,573,035.00

R5,352,296.22

R1,506,896.00

R600,000.00

R41,015,650.00

2

1

35

5

1

6

Please keep in mind that this is a loss register. This implies that the balances of the register must agree with the corresponding account in the general ledger. The bank will also base its BA reports on the information in this register. It was therefore important when you answered the question to keep to the table format to enable the markers to review the register.

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Analyse the losses per main risk type and illustrate with diagrams/graphs for discussion with EXCO (15 Marks).

Students should have used descriptive statistics e.g. Pie charts, bar diagrams or line charts to describe the volumes and values of the loss register.

At a main risk type level, the diagrams will show a concentration in operational risk in both the values and volumes, followed by credit and market risk.

Further analysis of operational risk shows that: 

the highest volume of losses (35) in the People category, with 6 external events, 5 process events and 1 system event.



external events had the highest loss, followed by people, process and systems.

Some students went further and classified the operational risk sub categories in terms of the loss event types i.e. internal fraud, external fraud and clients.

Conclusion Based on the results of the assignment, some students seemed to find the assignment challenging. The marks ranged from 90% to 4%.

The mistakes can be summarised as follows: 

students did not classify the losses into the main risk types. The main risk types were sometimes discussed, but the actual losses not classified. You need to know the risk definitions to be able to identify and classify risks in the following assignments and the examination. Refer to the study guide or the Basel documents for more clarity if you are uncertain regarding the risk definitions.



losses were in some cases not classified into the four operational risk sub-risk types.



currency conversions were based on the incorrect amounts or were done incorrectly.



the diagrams/graphs were not always meaningful and will be difficult to explain to an EXCO. The diagrams/graphs were also not always discussed.



Work was not always referenced.



Where students did reference work, it was limited to the prescribed book.

RSK4801

This module is offered at a postgraduate level. At a postgraduate level, students have to refer to other sources than only the prescribed book in the assignments and as part of the preparation for the examination. The study guide/notes in the Learning Units are your lectures and form the basis for the course.

References

Blunden, T. Thirlwell, J. 2013. 2nd Edition. Mastering Operational Risk. Harlow Pearson Education Ltd. Sound Practices for the Management and Supervision of Operational Risk. Consultative Document

February

2011.

Basel

Committee

on

Banking

Supervision.

www.bis.org/publ/bcbs183.htm (Accessed 2011/04/10). Young, J. 2006. Operational Risk Management: The practical application of a qualitative approach. Pretoria: Van Schaik Publishers.

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