Module: | MODULE B: RISK MANAGEMENT
Q403: Consider the following statements regarding the core definition and boundary exclusions of Operational Risk under the Basel framework:
1. Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events.
2. The Basel framework strictly includes both legal risk and strategic risk within the definition of operational risk for capital calculation.
3. Reputational risk is completely excluded from the quantitative measurement of operational risk under standard Basel norms.
Which of the statements given above is/are correct?
2. The Basel framework strictly includes both legal risk and strategic risk within the definition of operational risk for capital calculation.
3. Reputational risk is completely excluded from the quantitative measurement of operational risk under standard Basel norms.
Which of the statements given above is/are correct?
✅ Correct Answer: B
The correct answer is B. Statement 1 is correct: This is the exact, standard Basel definition of Operational Risk.
It encompasses losses from inadequate or failed internal processes, people, and systems, or from external events.
Statement 2 is incorrect: While the Basel framework explicitly includes Legal Risk (which covers fines, penalties, and punitive damages resulting from supervisory actions or private settlements), it strictly excludes Strategic Risk.
Strategic risk relates to poor business decisions or improper implementation of decisions, which is beyond operational failures.
Statement 3 is correct: Reputational risk, the potential that negative publicity regarding an institution's business practices will cause a decline in the customer base, costly litigation, or revenue reductions, is explicitly excluded from the standard definition of operational risk because it is highly subjective and difficult to quantify for regulatory capital allocation.
Therefore:
Option A is incorrect because Statement 2 is false.
Option B is correct as both Statement 1 and 3 are true.
Option C is incorrect because Statement 2 is false.
Option D is incorrect because Statement 2 is false.
It encompasses losses from inadequate or failed internal processes, people, and systems, or from external events.
Statement 2 is incorrect: While the Basel framework explicitly includes Legal Risk (which covers fines, penalties, and punitive damages resulting from supervisory actions or private settlements), it strictly excludes Strategic Risk.
Strategic risk relates to poor business decisions or improper implementation of decisions, which is beyond operational failures.
Statement 3 is correct: Reputational risk, the potential that negative publicity regarding an institution's business practices will cause a decline in the customer base, costly litigation, or revenue reductions, is explicitly excluded from the standard definition of operational risk because it is highly subjective and difficult to quantify for regulatory capital allocation.
Therefore:
Option A is incorrect because Statement 2 is false.
Option B is correct as both Statement 1 and 3 are true.
Option C is incorrect because Statement 2 is false.
Option D is incorrect because Statement 2 is false.