Speaker 1: There are three primary risks in banking. What are the primary risks? Credit risk, market risk, and ops risk. And historically it is credit risk, you know what it is, a bank gives a loan, the person goes bankrupt, okay, they have lost their money, okay, that's credit risk. And when a bank gives a loan, they have to find out if the person they give the loan to is actually going to pay it back, that would be nice. So that's credit risk. You know what market risk is? They are going to invest the money that they have in some market, it can be any type of market, equities, fixed income, or whatever, something will happen in the market, or maybe some foreign markets, there is market risk. And then there is ops risk. And by the way, the regulators are interested in these three risks. So the big regulators of all countries actually, big regulators, they want to see of a bank what are you doing, how are you doing, how are you measuring your ops risks, these three credit risks, okay. Just to tell you a little bit where ops risks fit in the whole thing. The primary risk events on a company level are these three risks here, I come from operations management area, and I think ops risk is the most important. By the way, there are some propagation effects of these risk events. What are the propagation effects? If there is too much risk and things don't go your way, that can be for a company, there can be liquidity risks. So that's sort of the ensuing risks. Liquidity risk or reputation risk. You know what happened with the breach at JPMorgan Chase, that they lose 70 million people and small businesses, all their information, the reputation of, hey listen, JPMorgan Chase, you're a nice bank, but do you really know what you're doing? So there is some reputation risk, that's sort of a follow-up risk, that's usually, it has time-wise a couple of months that it will take to hit. And then you have industry level risk, because if too much liquidity risks happen with too many companies, there can be a systemic risk, there can be contagion risk, and that can be an industry-wide risk. So this is a way of looking at risks, but this is a way of looking at risks from an operations management point of view. Let's look at what is the definition of operational risk according to Basel II. All of you know what, I hope all of you know what Basel I, Basel II, and Basel III are. It's the risk of a loss resulting from inadequate or failed internal processes, people, or from external events. You have internal processes, people, or external events. So the problem can be, well first of all, how are you going to, how can you make investments to mitigate operational risk, the type of investment? You have to invest in your human resources, invest in your traders, and also by the way in the supervision of your traders, your auditors, and your IT personnel, et cetera. You have to invest in IT, believe it or not, investment in IT. If your systems break down, and by the way there have been very interesting cases of systems break down that cost an enormous amount of money, because first of all, the moment systems break down, people are making more human errors, there are propagation effects, there is a lot of positive correlations with other events happening, so the cost of a breakdown, usually it's, and people measure actually every day level on any trading floor, how many minutes that day is the system down. And if the system has been down over the day, a total of ten minutes, let's say one minute here or there, a total of ten minutes it has been down, you know that there have been operational risk losses, because the moment a trader puts in a trade, and he has to wait a minute before things are being executed, something is going to happen against him in the market. So maybe it's also a highly volatile day, or a high volume day, things can happen. So you have to do IT investments, cost of computing and telecommunication equipment, and you have to do backups, all that, those are investments you have to make. By the way, there is something else, nowadays you can buy, no actually they stopped selling that, there was a reason why they stopped selling that, but after all those rogue traders came along, there were insurance companies that say, hey listen, we can sell you insurance against rogue trading, and by the way, the regulators, they know that some companies buy insurance against having a rogue trader in their house, and if you buy insurance, they will reduce their requirements on capital reserves against operational risk. So there is an incentive actually to insure yourself. And by the way, there is even a company like JPMorgan Chase, who really doesn't have to insure itself, because JPMorgan Chase has money in the bank, it's not really a very poor company, it has some money, it doesn't need to insure itself. Still they may insure itself, because why did they want to insure themselves? Because the insurance company comes in, and before they actually write an insurance on you, they're going to audit you, and they want to see how your processes are. And by the way, that is what JPMorgan Chase wants to see, let's see if this insurance company has experience with it, what they say about it, and then they buy insurance. And by the way, the insurance company won't sell it for more than a billion. So if the rogue trader makes five billion disappear, you get only one billion back from the insurance company. But you can do that. By the way, the last six months, the insurance companies have stopped doing that. It's not completely clear to me why they stopped writing insurance. I think they had a hard time quantifying the risk. Okay, so the types of operational risk losses, we can have transaction errors, we can have loss or damage to assets, theft, fraud, and authorized activities, regulatory, this one here, regulatory compliance and taxation penalties. Let me tell you, you may underestimate this, legal liability. Who of you heard which bank had to pay two months ago $250 million as penalty to New York State for not complying with anti-money laundering? Which bank was that? The Agricultural Bank of China. They have a big office in New York. Boy, the New York regulators got down on them. And they are having no problems. But the Agricultural Bank of China, the $250 million was actually, was not a big deal. It was just a warning to them. A warning that, hey, listen, you have to shape up, because we don't like this. And by the way, you have to pay us $250 million. It's not really a big deal, yeah, it's not a big deal. Okay, legal liability. Okay, so these are the types of operational risk losses. What are the operational risk factors? I give you here some general idea about operational. You have people risk. I told you already, people risk, they can be incompetent, unauthorized behavior, internal fraud, external fraud. It can be a client. For example, that money laundering, that was people risk, and it came from a client, and the client apparently was not checked well enough, or not sufficiently well enough, according to the regulators.