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Suggested Solutions Assignment 02: Operational Risk Management

This document provides feedback on Assignment 02 for the module Operational Risk Management (RSK 4801). It summarizes the key points students were expected to cover in their responses and common mistakes made. For question 1, students were asked to identify and evaluate operational risks for a company and plot them on a risk profile matrix. For question 2, students needed to explain aspects of an operational loss distribution graph to a risk committee. Question 3 involved illustrating the business continuity concept with a diagram and evaluating a company's response to a fire incident. The document concludes with a summary of mistakes, such as not classifying risks correctly or linking control strategies to the graph as required.

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Digong Smaz
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745 views5 pages

Suggested Solutions Assignment 02: Operational Risk Management

This document provides feedback on Assignment 02 for the module Operational Risk Management (RSK 4801). It summarizes the key points students were expected to cover in their responses and common mistakes made. For question 1, students were asked to identify and evaluate operational risks for a company and plot them on a risk profile matrix. For question 2, students needed to explain aspects of an operational loss distribution graph to a risk committee. Question 3 involved illustrating the business continuity concept with a diagram and evaluating a company's response to a fire incident. The document concludes with a summary of mistakes, such as not classifying risks correctly or linking control strategies to the graph as required.

Uploaded by

Digong Smaz
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Suggested Solutions

Assignment 02
Operational Risk Management

RSK 4801

Department of Finance, Risk Management


and Banking
This tutorial letter contains important
information about your module.

Open Rubric
Question 1

Identify and evaluate the operational risks for SPEND Ltd and plot the risks on an
Operational Risk Profile. Use the Risk Evaluation Matrix as provided. (10)

Suggested answer

EVENT Impact Likelihood


PE Warehouse fire (buildings + stock) 5 1
Damage to stock (R250m) 5 1
Damage to buildings (R50m) 3 1
Pilferage 4 5
Theft 2 5
Hijackings 1 3
Accidents 1 3

A number of students copied the risk register for the purposes of the risk profile. Please bear in
mind that if you have to make a presentation to your EXCO or Board, your time will be limited and to
be able to present the risk in a simple manner, a graphical format can be beneficial. However, you
were supposed to show how you determined the impact and likelihood as indicated in the solution to
RSK4801

assignment 01. Students did not earn any marks for discussing reputational or any other risk that is
not classified as operational risk.

Question 2

The CRO had a meeting with Hotshot Consultants Ltd. The consultant modelled the losses
for presentation to the Risk Committee. [20]

You were requested to explain the graph to the Risk Committee, by covering the following aspects:
• Interpretation of the graph
• Control strategy
• Risk financing strategy

Suggested answer

Interpretation of the graph (Refer to Young, 2014:99-101)


The loss distribution curve can be divided into three parts.
• The first part of the graph indicates a large number of small losses i.e. expected losses
characterised by low frequency and low severity such as pilferage and theft.
• The second part is where the number of losses reduces and, the value of the losses
increases but are still what can be expected as part of the business, and
• The last part illustrates limited available data i.e. unlikely but plausible events and significant
losses thus, unexpected losses. E.g. the PE warehouse fire.

3
The control strategy for the first part is:
• If the losses in this category are within the risk tolerance of the business, management can
accept the losses or improve the preventative controls to reduce the likelihood or the detective
controls, should management decide the losses are breaching the risk tolerance levels. The firm
can finance the risk by improving the controls, raising provisions to absorb the losses. Standard
insurance is not necessarily the most optimum option as the premiums may be prohibitive.
• The second part of the diagram also warrants an improvement of the control environment. The
firm can also consider transferring the risk by insuring against the events.
• The last part of the diagram requires contingency controls such as a business continuity plan
should an event occur with a low probability and a significant loss/impact occurrence. Although
insurance against such events can be purchased, the cost can be prohibitive and companies
can consider more advanced risk financing techniques such as captive insurance, finite
insurance, contingency finance such as capital reserves and contingency loans.

Question 3 [20]
a. Illustrate the business continuity concept by means of a diagram. (10)

Source: Online study guide

Please note that the question required you to illustrate the business continuity concept by means of
a diagram only. Therefore, those who did not include a diagram were not awarded any marks.

4
RSK4801

b. Evaluate SPEND’s actions with regard to the fire at the Port Elizabeth distribution centre and
what you would implement to mitigate the impact. (10)

Suggested answer
The contingency plan for PE relied on a 10 minute response by the PE Fire Brigade and the
sprinkler system of the distribution centre to contain the fire until the Fire Brigade arrives. The
contingency plan did not provide for any action if the distribution centre was destroyed.

Staffs were slow to react when they noticed the fire as they underestimated the severity.
Management was only alerted to the fire after staff was not able to extinguish the fire with a garden-
hose and fire buckets. By that time the fire started to spread into the building, management was only
able to alert the Fire Brigade after the distribution centre was burning out of control. Total damage to
the buildings and stock amounted to R300m. Additional loss in trade of R50m was incurred as it
took three months to rebuild the centre and an additional cost of R5m was incurred to supply stores
from other distribution centres.

The contingency measures need to address the following:


Contain the damage and to continue with normal business as early as possible. The following
should be considered as part of the contingency plan:
• Identification of an event i.e. the fire
• Escalation of the event i.e. staff should have reported the fire immediately
• Notify the fire brigade immediately
• Pre-arranged temporary distributing facilities or if not available consider dual distribution
facilities in the Eastern Cape
• Business interruption insurance

Conclusion
Based on the results of the assignment, some students seemed to find the assignment challenging.

The mistakes can be summarised as follows:


• Students did not classify the operational risks correctly. The main operational risks were
sometimes discussed, but the impact and likelihood were not always determined.
• For question 2, interpretation of the graph was not based on the given LOSS FREQUENCY
DISTIBUTION graph and the control and risk financing strategies were not linked to the graph.
• Work, especially the diagram in question 3a was not always referenced. Whatever the source of
the diagram, you are expected to reference your work at all times.

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