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

A firm describes operational risk as everything that is not market or credit risk. What is the main weakness of this residual definition compared with the Basel causal definition?

Its main weakness is that it does not identify the causes of loss, so it is too broad to guide risk identification, control design and measurement. The Basel definition is cause-based, focusing on failed processes, people, systems and external events, which gives operational risk a clearer scope.

  1. AIt is too narrow and excludes legal risk
  2. BIt fails to identify the causes of loss, making identification and measurement less focusedCorrect
  3. CIt requires reputational risk to be quantified
  4. DIt applies only to banks and not other firms

Explanation

A residual definition is overly broad and gives no insight into causes, so it cannot guide identification, controls or measurement. The Basel cause-based definition focuses on processes, people, systems and external events. It does not exclude legal risk, and it does not require quantifying reputational risk.

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