A B C D E F G H I J K L M N O P Q R S T U V W X Y Z

A

Advanced Measurement Approach (AMA)

A group of risk sensitive methods used to calculate the capital charge for operational risk. See Basel 2

B

Back Testing

The practice of comparing actual data with predicated data I order to ensure the veracity of a predictive model.

Basel 2

An international accord on bank capital requirements to replace the earlier 1988 Basel Accord. The new capital adequacy framework establishes an explicit capital charge for a bank’s exposures to operational risk, ie, the risk of losses caused by failures in systems, processes, or staff or that are caused by external events. Also known as Basel II, Basle 2, Basle II and New Basel Accord.

Basel Accord (1988)

An international accord on bank capital requirements.

Basel Accord (1996 Amendment)

An amendment to the 1988 Basel Accord that added capital requirements for market risk.

Basel Committee

An international committee that has has played a leading role in standardizing bank regulations across jurisdictions.

Benchmarking

The process of comparing performance against best practice in similar organisations, or similar processes in different organisations, during the same period. Also known as cross-sectional analysis, horizontal analysis, or peer analysis. In the context of operational risk it is the comparison of a firm's loss data and measures of operational risk with competitors and other firms in the industry.

BIS

Bank for International Settlements. An international organization which fosters international monetary and financial cooperation and serves as a bank for central bank.

Bottom-Up Measurement

A method of measuring operational risk that builds up a detailed profile of risks occurring in each process, aggregating these risks to provide overall measures of exposure for the department or firm as a whole.

Business Risk

The risk of loss due to an adverse external environment such as high inflation affecting labour costs; an over-competitive market reducing margin; or legal, tax or regulatory changes in the markets.

C

CAD

Europe's 1993 Capital Adequacy Directive.

CAD II

A 1998 update to CAD.

CAD III

European regulation implementing the Basel II Accord

Combined Code

The Financial Reporting Council (FRC) published the new Combined Code on Corporate Governance in July 2003. The code establishes best practice with regard to: responsibilities of the Board; Remuneration; Accountability and Audit; and Relations with Shareholders. The publication includes the Code itself and related guidance (the Turnbull guidance on Internal Control, the Smith guidance on Audit Committees, and various pieces of good practice guidance from the Higgs report).

Compliance Risk

The risk to earnings or capital arising from violations, or non-conformance with laws, rules, regulations, prescribed practices or ethical standards.

Confidence Level

An assessment of the probability that an event will occur, usually expressed as a percentage.

Confirmation Process

The process of agreeing the details of a transaction with a counterparty.

Contingent Risk

A type of risk which will only exist if a particular event or situation happens.

Contingency

A condition or situation, the ultimate outcome of which, gain or loss, will be confirmed only on the occurrence, or non-occurrence, of one or more uncertain future events.

Control

An operational process that exists to either reduce probability of an error occurring (see Preventative Control) or the impact of the error should it occur (see Detective Control).

Corporate Governance

The mechanism whereby companies are governed, including systems and structures through which a company interacts with outside holders of ownership claims and the processes adopted by boards of directors to exercise the rights delegated to them by outside claimants. This typically considers how the activities of directors are controlled by the owners and other parties or stakeholders interested in the company's performance.

Correlation Simulation

A VaR measure that calculates the volatility of each risk factor from historical data an estimates its effect on the portfolio to give an overall composite VaR that includes all risk factors.

COSO

Committee of Sponsoring Organizations (COSO) Framework for regulatory compliance and risk management.

Credit Risk

The potential loss of earnings or capital due to an obligor's failure to meet the terms of a contract or otherwise fail to perform as agreed.

D

Detective Controls

Operational controls that detect errors once they have occurred and prevent further losses.

Direct Loss

The direct financial penalty that a firm incurs as a result of a risk being realised.

Distribution Analysis

A statistical means of using historical data to predict future events.

Downside

The negative aspect of incurring risk.

E

Earnings-Based Measurement

A means of accounting for the financial impact of operational risk by assessing the volatility of earnings after credit and market risk factors have been discounted and attributing this volatility to operational risk factors.

Economic Pricing Models

Models that are used to account for the financial impact of operational risk by linking the consequences of operational risk with fluctuations in the firm's share price.

Expected Loss

Expected value of losses, due to operational risk events over a specified time horizon.

External Detective Controls

Controls that detect errors and losses once they have been realised, ie, they detect the consequence.

External Environmental Causes

Environmental causes of operational risk arising from external influences such as economics, law, tax policies and natural events (eg, fire and flood).

F

Fiduciary Responsibility

The duty of care and trust an individual, corporation or association has when holding assets for another party.

Financial Risk

The quantifiable likelihood of loss or less-than-expected returns.

H

Historical Loss Analysis

The process of identifying previous loss events and attributing them to operational risk event types or causes.

Historical Simulation

The simplest form of VaR calculation that uses actual historic data to estimate risk exposure in the future.

I

Impact

The resultant effect of a risk being realised. May be a quantitative (numeric/ monetary) or qualitative measure.

Indirect Loss

The loss associated with the opportunity costs or losses of a risk being realised.

Indirect Market Risk Factors

The factors that have an indirect bearing on an instrument's price, such as interest rate levels, economic events, political and environmental effects.

Integrated Risk Management (IRM)

A philosophy that provides a firm with the ability to understand and address any risk in any area in the most effective way.

Internal Detective Controls

Controls that detect errors once they have occurred but before a potential loss is realised in the outside world, ie, they detect the internal effect in order to prevent the consequence.

Internal Environmental Causes

Environmental causes of operational risk arising from a firm's business strategy.

K

Key Risk Indicators (KRIs)

Objective measurement criteria that measure a firm's ongoing risk status.

Kurtosis (KRIs)

A parameter describing the peakedness and tails of a probability distribution.

L

Legal Risk

The risk of loss due to legal actions or uncertainty in the applicability or interpretation of contracts, laws or regulations.

M

Market Risk

The potential loss of earnings or capital arising from changes in the value of portfolios of financial instruments.

Market Liquidity Risk

The risk of loss through not being able to trade in a market or obtain a price on a desired product when required.

Materiality

Information is material f its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.

Mean

The average set of values, calculated by dividing the sum of all the values in the population by the total population.

Metrics

An alternative term for performance measure.

Model Risk

The risk that models are applied to tasks for which they are inappropriate or are otherwise implemented incorrectly.

N

Negative Correlation

An inverse, or opposite relationship between two factors.

Netting

The practice whereby two parties who exchange multiple cash flows during a given day agree bilaterally to net those cash flows to one payment per currency, thereby reducing settlement risk.

New Basel Accord

The new capital adequacy framework that establishes an explicit capital charge for a bank’s exposures to operational risk, ie, the risk of losses caused by failures in systems, processes, or staff or that are caused by external events. See Basel 2 Basel II, Basle 2, Basle II.

Normal Distribution Curve

A common form of probability distribution which has a "bell shape", is continuous, symmetrical about its mean and is defined by its mean and standard deviation.

O

Off-Balance-Sheet Transaction

A transaction that is not required to be reported in a firm's financial accounts.

On-Balance-Sheet Transaction

A transaction that is required to be reported in a firm's financial accounts.

Operational Controls

Activities that are inserted into a process to protect it against specific operational risks.

Operational Risk

The risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events.

Operational Risk Policy

A framework for operational risk management.

Outsourcing

The transfer of an aspect of a firm's business to a third party who will carry the risk exposure for a fee.

P

Pillar 1

The rules in the New Basel Capital Accord that define the minimum ratio of capital to risk weighted assets.

Pillar 2

The supervisory review pillar of the New Basel Capital Accord, which requires supervisors to undertake a qualitative review of their bank's capital allocation techniques and compliance with relevant standards.

Pillar 3

The disclosure requirements of the New Basel Capital Accord, which facilitate market discipline.

Position Reconciliation Process

The process of ensuring that all managed positions are the same as those being settled.

Positioning Process

The process of ensuring that there is sufficient cash or stock available to fulfil the contract.

Post-Settlement Stage

The third stage of a transaction's lifecycle involving the movement of, and control over, cash and physical assets.

Potential Exposure

The likely maximum loss (for a specified confidence level) in the event of default at a particular point in time.

Pre-Settlement Risk

The risk that an institution defaults prior to settlement when the instrument has a positive economic value to the other party.

Pre-Settlement Stage

The second stage of a transaction's lifecycle involving the capture and agreement of transaction-specific data.

Preventative Controls

Operational controls that prevent errors occurring.

Probability Distributions

Mathematical functions that describe the probabilities of possible outcomes occurring. They are depicted as graphs with the "probability of occurrence" on the vertical axis and the "possible outcome" on the horizontal axis.

Probability

The likelihood that a risk with occur. Usually measured in percentage terms.

Process

A set of activities that allows the firm to deliver its product to the customer. A process takes a collection of inputs and turns them into desired outputs by adding value to them.

Project Risk

The risk that the failure or partial failure of a project to meet its objectives leads to financial loss.

Prudence

The inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated.

R

Ranking

A method of assessing risk by estimating the likelihood of it being realised and the magnitude of its impact. This information is usually depicted graphically.

Reconciliation

An accounting function that ensures the firm's record of cash and stock movements agrees with its statement of balance and holdings.

Regulatory Risk

The risk to earnings or capital arising from violations, or non-conformance with laws, rules, regulations, prescribed practices or ethical standards. See Compliance Risk.

Risk

A measure of uncertainty comprising uncertainty/ probability and exposure/ impact. Downside risk is the hazard or chance of bad consequences or loss occurring.

Risk Management

The implementation of a strategic process that reduces the likelihood of risks being realised to acceptable levels.

Risk Mapping

The process of assessing for the organisation as a whole the types and degree of risk to which it is exposed.

Risk Measure

An operation for quantifying risk.

Risk measurement is concerned with understanding the size of a risk by trying to predict a future event using past knowledge.

Risk Profile

The types of operational risks that are faced by a firm and its exposure to those risks.

S

Sarbanes-Oxley Act (2002)

Also known as the Public Company Accounting Reform and Investor Protection Act responds to a number of high profile corporate scandals, involving Enron, WorldCom, Arthur Anderson and others. The (US) Act radically redesigned federal regulation of public company corporate governance and reporting obligations.

Scenario Analysis

A subjective method of highlighting potential risk issues in order to allow preventative action to be taken.

Settlement

The physical delivery of an asset in exchange for an equivalent amount in cash.

Settlement Risk

The risk that occurs when there is a non-simultaneous exchange of value and one party defaults.

Set-Up Stage

The first stage of a transaction's lifecycle involving all pre-transaction activities.

SOX

See Sarbanes-Oxley Act (2002).

Standard Deviation (SD)

A means of measuring variability, uncertainty or volatility of return. It measures how spread out values are from the average (mean).

Standard Normal Distribution(SD)

The normal distribution with mean 0 and variance 1.

Strategic Risk

The risk of loss due to sub-optimal strategy being employed and associated with the way the institution is managed. For instance, a competitor or product strategy may be employed that fails to maximise the return on the investment made.

Stress Testing

A means of testing the accuracy of VaR models against "extreme" market conditions.

T

Trade Instruction Process

The process of agreeing delivery instructions with a third party.

Transaction Capture

The activity of capturing trades in back office systems.

Turnbull

Authored by Nigel Turnbull and published by the ICAEW, the Turnbull Report represents the final element in the Combined Code on Corporate Governance. From 23 December 2000 all (London) Stock Exchange listed companies are required to identify, evaluate and manage their significant risks and to assess the effectiveness of the related internal control system. See Combined Code.

U

Ultra Vires

A legal term meaning in excess of legal power.

Upside

The positive aspect of incurring risk.

V

Value-at-Risk (VaR)

The maximum loss that can occur with a specified confidence over a specified period of days.

Value Chain

A number of processes that must occur to achieve a desired outcome.

Variance/ Co-Variance Simulation

A VaR measure that calculates the volatility of each risk factor from historical data an estimates its effect on the portfolio to give an overall composite VaR that includes all risk factors.

Volatility Risk

The risk of price movements that are more uncertain than usual, affecting the pricing of products.

Volume Sensitivity

The process cause of operational risk where the workload increases in proportion to increasing volumes.

W

Whistleblower System

A mechanism for anonymous reporting.