Operational Risk Scenarios and Stress Testing

FOCUS ON: Case studies,

SUMMARY

The client, a UK asset manager, provides services to both retail and institutional clients across different asset classes in the UK and the European market. It requested support to enhance the operational risk scenarios and stress testing framework as a part of the ICAAP.

CUSTOMER GOALS

Considering that operational risk was the largest component of the capital requirement for the client as well as the common area of regulatory focus, it was defined as one of the key areas for potential enhancement within the ICAAP exercise along with the stress testing process. Furthermore, the CRO was unconvinced that the existing approach and scenarios employed for operational risk assessment were appropriately designed and capturing all relevant risks, especially given the significant changes in the existing risk profile following a material increase of the business size. As a result, the client requested that Avantage Reply perform a comprehensive review of the scenarios and the framework.

CHALLENGES

Considering that at this point the client was going through significant changes related to the scale of the business, this had to be reflected in the stress testing scenarios, framework and related methodologies. The review process was particularly challenging given the need to organise a large number of operational risk scenario workshops with all the business lines remotely. In addition, the timelines were significantly shortened because the company had to undertake the ICAAP process twice during the same year to meet a regulatory request.

APPROACH AND SOLUTIONS

The approach adopted by Avantage Reply ensured that the operational risk framework and stress testing approach meet the regulatory requirements and are aligned with the industry best practice. It included the following steps:

Facilitate the operational risk scenario workshops and ensure that information provided by the SMEs is reflected in the respective scenarios;
Amend the existing scenarios by performing a detailed assessment of the inputs and assumptions and develop new stress scenarios to address the risk that were previously not captured;
Quantify the impact of each scenario including validating the accuracy of the implementation and perform respective capital requirements estimation;
Develop and document the respective sections of the ICAAP report, ensuring that the information provided is both coherent and comprehensive.

RELATED CONTENTS

Case Study

FRAUD RISK: AN EXAMPLE OF OPERATIONAL RISK ASSESSMENT

The client, a crypto-currency exchange, has requested Avantage Reply to assist with an ongoing project around fraud risk. As the regulation around virtual asset service providers is not yet mature, the measurement of new and non-traditional operational risks is not an easy exercise. In fact, several players in the industry have recently found themselves being vehicles for the continuation of various financial crimes, including fraud. In the client landscape, scammers and individuals with malicious intentions have exploited the weaknesses of decentralized finance (DeFi) and have misappropriated even millions of dollars from their victims through first party or third party external fraud.

Case Study

Embedment of ICAAP & ILAAP exercise

Avantage Reply has assisted a Private Banking group in the Eurozone in their embedment of Internal Capital Adequacy Assessment Process (ICAAP) & Liquidity Adequacy Assessment Process (ILAAP) exercise, s.c. ICLAAP. Following the recommendation of the European Central Bank (ECB), bank’s current practice of ICLAAP had to be reviewed and challenged. The results of the review have been presented to the Management Body. In particular, identified gaps and attention points with respective actions to improve the way ICAAP and ILAAP are conducted. The analysis has been enriched with market best practices observed among various financial institutions in the Eurozone.