| The definition of operational risk adopted under Basel II is "Operational risk is defined as the risk of loss resulting from inadequate or failed processes, people and systems or from external events.";Regulatory requirements for operational risk management and measurement have been established under the Basel II rule, with local implementation rules developed by national regulators. The cost of operational risk losses and the impact of operational risk on share value have been established. As a result of these regulatory and financial drivers, financial services firms are seeking robust operational risk frameworks to enable them to meet the four core operational risk requirements to identify, assess, control, and mitigate operational risk.;This paper researches the regulatory landscape including a historical review of The Bank of International Settlements (BIS) rules regarding operational risk. The author reviews the local rules that have been adopted in the United States and across Europe. This review includes the Group of Twenty (G20) push for stronger adoption of risk regulation since the financial crisis began in 2007, including U.S. Dodd-Frank legislation, European Directives, Sound Practices documents and Basel III.;The paper analyzes sources of operational risk data to determine the size of operational risk losses and the main drivers for those losses. IBM Algo FIRST subscription data and ORX consortium data sources are used for this analysis. The relative biases in subscription data and consortium data are discussed. In addition, a literature review summarizes previous findings regarding the impact of operational risk and reputational risk events on share value. This review is supplemented by original analysis of the impact on share price and trading volumes as a result of the recent JP Morgan Whale operational risk event.;The paper concludes with a recommended operational risk framework for the implementation of the important elements of an effective operational risk framework. These elements include the foundations of governance, risk appetite, culture and awareness, and policy and procedure; the building blocks of data collection including loss data, risk and control self-assessment, scenario analysis, and key risk indicators; and the final capstones of calculation of capital and reporting. |
