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FRM Part II · FRM Exam Part II · Introduction to Operational Risk and Resilience

A bank's risk team is classifying a loss event. A trader entered a trade with the wrong counterparty because of a keying error, and the bank later lost money when the correct hedge was not placed. Under the Basel definition of operational risk, how should this loss be classified?

The loss is operational risk. Basel defines operational risk as loss from inadequate or failed internal processes, people and systems, or external events, and a keying error is a people and process failure. Subsequent market movements only determine the loss size, not its cause.

  1. AOperational risk, because it results from an inadequate or failed internal process, people or systemCorrect
  2. BMarket risk, because the loss arose from a price movement in a traded position
  3. CCredit risk, because a counterparty was involved in the transaction
  4. DStrategic risk, because it affected the bank's trading business

Explanation

Basel defines operational risk as the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. A keying error is a human/process failure. The market move is only the consequence, not the cause, so classifying it as market risk is wrong.

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