Explanation:
Operational risk involves losses resulting from inadequate or failed internal processes, people, and systems. In the context of collateral management, inaccurate valuation of collateral is a clear failure in internal processes or systems. This inaccuracy can lead to incorrect margin calls, inadequate collateral postings, and subsequent legal or counterparty disputes, which are classic examples of operational risk.
Option B describes a strategy for mitigating market and credit risk, not operational risk. Option C is incorrect because collateralization inherently introduces operational risks (e.g., legal, settlement, and valuation risks). Option D is too broad and fails to specifically address how operational risk arises from the collateralization process itself.
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Q.5497 Global Finance Bank (GFB) is reviewing its risk management practices, focusing on the operational risks associated with the collateralization of its OTC derivatives portfolio. During a period of market volatility, GFB has encountered several challenges in its collateral management process. Based on the following scenarios, which one accurately demonstrates how operational risk can arise in the context of collateralization?
A
Operational risk emerges due to inaccurate valuation of collateral, leading to inadequate collateral postings and potential disputes with counterparties.
B
Operational risk is mitigated through the use of diversified collateral, reducing the bank's exposure to any single asset's volatility.
C
Operational risk is unaffected by collateralization practices, as it is primarily concerned with market fluctuations and credit risk management.
D
Operational risk increases as GFB engages in more OTC derivatives transactions, irrespective of the collateralization process.
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