Legal risk

Basel II classified legal risk as a subset of operational risk in 2003. This conception is based on a business
perspective, recognizing that there are threats entailed in the business operating environment. The idea is
that businesses do not operate in a vacuum and in the exploitation of opportunities and their engagement
with other businesses, their activities tend to become subjects of legal liabilities and obligations.[1]

One of the primary reasons why legal risk is associated with operational risk involves fraud since it is
recognized as the most significant category of operational loss events and considered to be a legal issue as
well.[2] This, however, does not mean that legal risk is only confined to this conceptualization. For instance,
there are specific sets of legal risks that are defined by European Union (EU) Law. In 2005, the European
Central Bank declared that it will develop its own legal risk definition to help "facilitate proper risk
assessment and risk management, as well as ensure a consistent approach between EU credit
institutions."[3]

Further developing legitimate risk the board for any organization does not require many steps. This process
won't prevent each lawsuit or administrative punishment, however, it can reduce lawful risks and enhance
the organization's responses.[4]

Hazard is intrinsic in any business undertaking, and great danger management is a fundamental part of
maintaining a fruitful business. An organization's management has shifting degrees of control concerning
hazards. A few dangers can be straightforwardly overseen; different dangers are largely outside the ability
to control organization management. Everything an organization can manage is to attempt to expect
potential dangers, survey the possible effect on the organization's business, and be ready with an
arrangement to respond to unfavorable occasions.[5]

Definitions
There is no standard definition, but there are at least two primary/secondary definition sets in circulation.

McCormick, R. 2004

Legal risk is the risk of loss to an institution which is primarily caused by:
(a) a defective transaction; or
(b) a claim (including a defense to a claim or a counterclaim) being made or some other event occurring
which results in a liability for the institution or other loss (for example, as a result of the termination of a
contract) or;
(c) failing to take appropriate measures to protect assets (for example, intellectual property) owned by the
institution; or
(d) change in law.[6]

McCormick, R. 2004

Management of legal risk is not a precise science and subjective to the situation of the institution, and
primarily caused by the lack of proper communication channel, undefined institutional objectives (such as
the lack of policies and regulations), unclarified information flow between different personnel and
department, lack of delegation of power to specify task on mitigation of risks.[7]
Johnson & Swanson. 2007

The expenses of litigation of a company.[8]

Whalley, M. 2016

Legal risk is the risk of financial or reputational loss that can result from lack of awareness or
misunderstanding of, ambiguity in, or reckless indifference to, the way law and regulation apply to your
business, its relationships, processes, products and services.[9]

Tsui TC. 2013

The cost and loss of income caused by legal uncertainty, multiplied by possibility of the individual event or
legal environment as a whole.[10] One of the most obvious legal risks of doing business not mentioned in
the above definitions is the risk of arrest and prosecution.

Types
Regulatory Risks turning into legal risks: These are the risks that arise out of regulations
and laws that govern a business organization or the market in which it operates. Every
country and the government lays down certain laws and regulations for the proper
operations of the businesses. And all the businesses have to comply with those rules and
regulations of the land. Moreover, any non-compliance can have serious consequences for
any organization. Therefore legal expenses insurance may be used to mitigate this risk.[11]
Compliance Risk: The potential for fines and penalties for an organization that fails to
comply with laws regulations.
Contract Risk: The potential for a partner, customer or supplier to fail to meet the terms of a
contract resulting in losses. Contract risk can also result from the failure to meet the terms of
a contract resulting in penalties or legal disputes.
Non-contractual Rights: The potential for a third party to infringe on its non-contractual
obligations.
Dispute Risk: The potential for a legal dispute to arise as a result of business activities.
Reputational risk: The potential of the decline of reputation due to legal actions.

Consequences
Legal risk can lead to fines and administrative penalties, the need for monetary damages, deterioration of
reputation, deterioration of the bank's market position, narrowing opportunities for development, reducing
the opportunities for development or legal enforcement of agreements.

References
1. Chapman, Robert (2011). Simple Tools and Techniques for Enterprise Risk Management.
Chichester, West Sussex: John Wiley & Sons. p. 435. ISBN 9781119989974.
2. Moosa, Imad (2007). Operational Risk Management. New York: Palgrave Macmillan. p. 95.
ISBN 9781349352951.
3. Mišćenić, Emilia; Raccah, Aurélien (2016). Legal Risks in EU Law: Interdisciplinary Studies
on Legal Risk Management and Better Regulation in Europe. Berlin: Springer. p. 6.
ISBN 9783319285955.
 4. Little, Mark. "6 Steps to Legal Risk Management | Risk Management | Articles" (https://www.
berkmansolutions.com/articles/risk/6-steps-to-legal-risk-management). Berkman Solutions.
Retrieved 2021-08-01.
5. J. B. Maverick. "What Are the Major Categories of Financial Risk for a Company?" (https://w
ww.investopedia.com/ask/answers/062415/what-are-major-categories-financial-risk-compan
y.asp). Investopedia. Retrieved 2021-08-01.
6. Roger McCormick. "Legal Risk in the Financial Markets", Oxford University Press
7. Roger McCormick. "The Management of Legal RIsk by Financial Institutions", RSM
8. IMA. "Issues" (http://www.imanet.org/resources_and_publications/management_accounting
_quarterly/issues/Fall_2007.aspx). imanet.org.
9. "Legal risk 2.0: Show you're in control" (http://www.ey.com/Publication/vwLUAssets/ey-legal-
risk-2-show-you-are-in-control/$FILE/ey-legal-risk-2-show-you-are-in-control.pdf) (PDF).
10. "Experience from the Anti-Monopoly Law Decision in China (Cost and Benefit of Rule of
Law)". ssrn.com. SSRN 2260965 (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=226
0965). {{cite web}}: Missing or empty |url= (help)
11. Masip, Gemma; Sabalza, Maite; Pérez-Massot, Eduard; Banakar, Raviraj; Cebrian, David;
Twyman, Richard M.; Capell, Teresa; Albajes, Ramon; Christou, Paul (2013). "Paradoxical
EU agricultural policies on genetically engineered crops". Trends in Plant Science. Cell
Press. 18 (6): 312–324. doi:10.1016/j.tplants.2013.03.004 (https://doi.org/10.1016%2Fj.tplant
s.2013.03.004). ISSN 1360-1385 (https://www.worldcat.org/issn/1360-1385).
PMID 23623240 (https://pubmed.ncbi.nlm.nih.gov/23623240).

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