This lesson explores operational risk, including its sources, measurement, and management, with a focus on model risk and emerging non-financial risks .

6.1 Defining Operational Risk
Operational risk is the risk of loss from failed internal processes, people, systems, or external events . It is a key risk category under the Basel framework and a major focus of internal controls . Sources include human error, system failures, fraud, legal risks, and external disruptions .

6.2 Model Risk
Model risk is a specific type of operational risk that has gained prominence following the 2008 financial crisis . It is the risk of losses from using models that are incorrect, misused, or misunderstood. The IRM syllabus includes “model risk” as a distinct risk category . This includes the risk that financial models used for pricing, hedging, and risk measurement are flawed .

6.3 Managing Operational Risk
Key approaches to managing operational risk include:

• Risk and Control Self-Assessment (RCSA): A process where operational managers identify risks and evaluate controls .

• Key Risk Indicators (KRIs): Metrics used to monitor operational risk .

• Business Continuity Planning (BCP): Plans to ensure the bank can continue critical operations during and after a disruptive event .

• Internal Controls: Segregation of duties, authorisation limits, and independent reconciliation .