Operational Risk (FRM Part 1 2025 – Book 4 – Chapter 7)
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After completing this reading, you should be able to:
Compare three approaches for calculating regulatory capital.
Describe the Basel Committee’s seven categories of operational risk.
Derive a loss distribution from the loss frequency distribution and loss severity distribution using Monte Carlo simulations.
Describe the common data issues that can introduce inaccuracies and biases in the estimation of loss frequency and severity distributions.
Describe how to use scenario analysis in instances when data is scarce.
Describe how to identify causal relationships and how to use Risk and Control Self-Assessment (RCSA) and Key Risk Indicators (KRIs) to measure and manage operational risks.
Describe the allocation of operational risk capital to business units.
Explain how to use the power law to measure operational risk.
Explain the risks of moral hazard and adverse selection when using insurance to mitigate operational risks.
0:00 Introduction
2:18 Comparing the Three Approaches for Calculating Regulatory Capital
4:53 Basic Indicator Approach
9:04 Standardized Approach
10:26 Advanced Measurement Approach
11:49 The Basel Committee's Seven Categories of Operational Risk
12:30 Loss Frequency And Loss Severity
17:19 Inaccuracies And Biases In The Estimation of Loss Frequency And Severity Distributions
18:22 Scenario Analysis in Instances When Data is Scarce
21:25 Causal Relationships, RCSA, KRIS
25:06 Allocation of Operational Risk Capital and the Use of Score Cards
26:04 The Power Law
27:13 Insurance to Mitigate Operational Risks