Discover 2014 Annual Report Download - page 30

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Risk Categories
We are exposed to a broad set of risks in the course of our business activities due to both internal and external
factors, which we segment into six major risk categories. The first five are defined to be broadly consistent with Federal
Reserve regulatory guidance and Basel: credit, market, liquidity, operational, and compliance/legal risk. We recognize
the sixth, strategic risk, as a separate risk category. We evaluate the potential impact of a risk event on the Company
by assessing the financial impact, the impact to our reputation, the legal and regulatory impact, and the client/customer
impact. In addition, we have established various policies to help govern these risks.
Credit Risk
Credit risk arises from the potential that a borrower or counterparty will fail to perform on an obligation. Our
credit risk includes consumer credit risk and counterparty credit risk. Consumer credit risk is primarily incurred by
Discover Bank through the issuance of (i) unsecured credit including credit cards, student loans and personal loans and
(ii) secured credit including secured credit cards, deposit secured loans and home equity loans. Discover Home Loans
incurs consumer credit risk through the issuance of residential first mortgage loans to consumers. Commercial credit risk
and residential first mortgage loans originated by Discover Bank are limited to certain Community Reinvestment Act
(“CRA”) compliance activities and the issuance of small business credit cards. Counterparty credit risk is incurred
through a number of activities including settlement, certain marketing programs, treasury and asset/liability
management, network incentive programs, vendor relationships and insurers.
The Discover Bank Credit Committee ensures the lending activities of the Bank comply with the Bank Credit Policy
and also identifies, measures, monitors and controls risk arising from consumer credit risk and commercial credit risk
associated with small business credit cards. Risks associated with CRA activities are overseen and monitored by the
CRA Committee of the Bank.
Our Counterparty Credit Committee is responsible for the enterprise-wide approach to counterparty credit risk
management through development of the Counterparty Credit Risk Management Policy and the associated oversight
framework for the identification, measurement, monitoring, managing and reporting of counterparty credit risk.
Market Risk
Market risk is the risk to our financial condition resulting from adverse movements in market rates or prices, such
as interest rates, foreign exchange rates, credit spreads or equity prices. We are exposed to various types of market
risk, in particular interest rate risk and other risks that arise through the management of our investment portfolio. The
Asset/Liability Management Policy governs the management of market risk.
Liquidity Risk
Liquidity risk is the risk that we will be unable to meet our obligations as they become due because of an inability
to liquidate assets or obtain adequate funding, or an inability to easily unwind or offset specific exposures without
significantly lowering market prices because of inadequate market depth or market disruptions. The Asset/Liability
Management Policy governs the management of liquidity risk.
Operational Risk
Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and
systems or from external events. Operational risk is inherent in all our businesses. Operational risk categories
incorporate all of the operational loss event-type categories set forth by the Basel Committee on Banking Supervision,
which include the following: (i) fraud (internal and external), (ii) employment practices and workplace safety, (iii) clients,
products and business practices, (iv) damage to physical assets, (v) business disruption and system failures, and (vi)
execution, delivery and process management.
Compliance and Legal Risk
Compliance risk is the operational risk of legal or regulatory sanctions, financial loss or damage to reputation
resulting from failure to comply with laws, regulations, rules, other regulatory requirements, or codes of conduct and
other standards of self-regulatory organizations applicable to us. Legal risk arises from the potential that unenforceable
contracts, lawsuits or adverse judgments can disrupt or otherwise negatively affect our operations or condition. These
risks are inherent in all of our businesses. Both compliance and legal risk are subsets of operational risk but are