A bank's primary business is accepting risk in exchange for a return. It borrows short, lends long, takes trading positions, and writes protection — every one of these activities transfers a loss distribution onto the firm's balance sheet. The question "how much capital should we hold against that loss?" is the operational heart of financial risk management, and the answer to it is the thread that runs through this entire unit.
This topic sets the conceptual and institutional stage before the mathematics begins. It covers three questions that every quant risk practitioner is expected to be able to answer without consulting a textbook: what kinds of risk exist and how are they distinguished; what regulatory machinery (Basel, Solvency II) governs how banks and insurers must measure and hold capital against those risks; and why firms manage risk at all — the shareholder and societal arguments, not just the regulatory mandate.
By the end of this topic you should be able to:
- articulate the difference between market risk, credit risk, operational risk, liquidity and model risk using concrete examples;
- describe the P&L distribution as the object that risk measurement is fundamentally about;
- sketch the Basel III pillar structure and explain what a risk-weighted asset is;
- state the Solvency II solvency capital requirement (SCR) and explain how it differs from the Basel approach;
- identify what failed in 2008 at the level of modelling assumptions and regulatory incentives;
- give both a shareholder-value and a systemic-stability argument for why a firm should measure and manage financial risk;
- place quantitative risk management on the map: what QRM adds beyond qualitative risk management.
In this lesson
- Contents
- The big picture
The full lesson is for members.
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