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

A bank's treasury dealer enters a trade at the wrong rate because the pricing model contained a coding error. The loss is USD 3 million. How should this event be classified under a risk taxonomy that separates market, credit and operational risk?

It is operational risk. The Basel definition classifies losses by their cause, and a coding error in a pricing model is a failed system or process. The loss shows up as a trading loss, but the underlying driver is not an intended market or credit risk position.

  1. AMarket risk, because the loss arose from a price movement
  2. BOperational risk, because the loss arose from a failed system or process rather than from a market move taken as a risk positionCorrect
  3. CCredit risk, because a counterparty was involved in the trade
  4. DLiquidity risk, because the trade had to be unwound

Explanation

The root cause is a coding error, which is an inadequate or failed system or process. Operational risk is classified by cause, not by where the loss appears in the accounts. Classifying it as market risk would confuse the loss's appearance with its source.

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