Defining Operational Risk
Jack L. King
We consider operational risk in the context of the firm. An analysis of various losses in terms of their causes and the events that trigger them is presented. The analysis provides the framework for the discussion of current definitions, which are then surveyed within that context. A clear and concise definition of operational risk is proposed. Famous losses attributable to operational risk, according to this definition, are reviewed. Finally, a set of success criteria for an approach to operational risk is presented.

Operational risk is emerging as the third leg of an enterprise-wide risk strategy for financial institutions. Several preliminary ideas have emerged, including actuarial-based methods, categorization of risk factors, and qualitative or subjective probability approaches. To date a well founded, clear and effective method of measuring and modeling operational risk is not available. A fundamental problem is the lack of consensus on its definition. This paper develops a definition for operational risk by first considering its general relation to the firm. A useful breakdown of causes, failures and losses is presented as a framework for discussion of current definitions. Then, a clear definition for operational risk is proposed, followed by a description of its relationship to famous historical losses. Finally, key success criteria are presented and suggestions for the direction of future efforts toward development of a consensus on an operational risk approach are made. This paper is the first of a series that develops a quantitative approach to operational risk using the existing framework for market and credit risk and which considers the purpose, feasibility and relevance of any proposed approach. The following questions are posed:
ALGO RESEARCH QUARTERLY

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What is the purpose of an operational risk management approach? Can a feasible measure be implemented that can be used to manage operational risk