… giving structure to the Basel risk categories and addressing opportunities as well as risks
Taxonomies of risk and opportunity
Introduction — inspired by Basel
The Basel Accord is a global, voluntary regulatory framework for banks. It encourages risk management framed around three components: credit risk, market risk and operational risk. Whilst such a framework is banking-centric, it inspires generalisation to all types of business, and gives rise to the risk taxonomy described below. Moreover, this in turn inspires the creation of an opportunity taxonomy.
All businesses operate within a market and in trading, deal with money. Thus all businesses are exposed to market risks and trading risks. It just so happens that a bank’s market is the money market, and therefore a bank’s market risks are synonymous with its trading risks, see table 1.
Moreover, all businesses have products (or services) and are thereby exposed to product risks. The principal banking product is credit, and therefore its product risks are synonymous with its credit risks.
There is another categorisation of risk, and that is the origin of the risk source: internal or external. Consider the risk “an organisation is not paid for work performed”. There are many reasons why it is not paid, e.g.:
All these have one thing in common — they are all within the organisation’s control, i.e., the source of risk is internal.
Despite ensuring that all such internally sourced risks are properly mitigated, the organisation still might not be paid — just because the customer is just like that, i.e., the customer just does not pay their bills. The source of risk in this case is external.
Moreover, this is an example of what Basel refers to as a credit risk and in the general case it is a product risk because if it wasn’t for the sale of a product, the risk of non-payment would not have arisen.
Basel refers to the internally sourced risks as operational risks. Thus, since all the risk categories in Table 1 can have internal and external risk sources, there will be operational risks that are associated with product, market and trading risks.
If product risk arises just because the organisation sells a product, it follows that market risk arise because of the market in which the organisation operates, and trading risks arise because money (and other assets) change hands, which need not be because a product is sold or work is performed.
In like vein, there is one other category of risk, that that is simply the risks to which an organisation is exposed merely because it exists. We refer to these as existence risks, for example risks associated with fire and flood.
Putting all this together generates the taxonomy shown in Figure 1.
The table shows that the Basel operational risk category comprises of five risk areas. Thus, this generalised risks taxonomy gives structure to the Basel risk categories.
We can proceed along similar lines to generate a taxonomy for opportunities, see Figure 2. In this case, there are three primary categories of opportunity: the first associated with the products and services that the organisation has to offer, and the second two being associated with general characteristics of all organisations: value and buying power. In each case, opportunities are facilitated either internally or externally. If the opportunity is created by the organisation, it is internally facilitated. If the opportunity is created by another organisation, it is externally facilitated.
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|Page last updated: February 14, 2023