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Operational risk management
This document discusses operational risk management. It begins with definitions of operational risk and management of operational risk. It then lists common causes of operational risk including internal and external fraud, employment practices, clients/products, damage to assets, business disruption, execution errors, highly automated technology, e-commerce, outsourcing, and mergers and acquisitions. It discusses approaches to calculating capital charges for operational risk under the basic indicator, standardized, and advanced measurement approaches. It also outlines factors for assessing and measuring operational risk events, monitoring operational risk, and data needs for operational risk management. Finally, it discusses management tasks related to operational risk mitigation and the typical organizational set-up for operational risk management.
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Operational risk management
- 1. Operational Risk Management MemberEducation Series Seminar Indian Institute of Banking & Finance Nagpur November 2005 1
- 2. Agenda Definition Causes/Contributors Process Gross Income Computation ofCapital Charge Approaches Assessing events Measurement basis Monitoring Data requirements Management tasks 2
- 3. Definitions Operational risk (OpRisk)hasbeen defined by the Basel Committee on Banking Supervision as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. Management of Operational Risk means and includes identification, assessment, monitoring and control/mitigation of this risk. 3
- 4. Causes of OpRisk •Internal fraud • External fraud • Employment practices and workplace safety • Clients, products and business practices. • Damage to physical assets. • Business disruption and system failures • Execution, delivery and process management 4
- 5. Causes of OpRisk •Highly Automated Technology • Emergence of E- Commerce • Emergence of banks acting as very large volume service providers • Outsourcing • Large-scale acquisitions, mergers, demergers and consolidations • Engagement in risk mitigation techniques giving rise to legal risk 5
- 6. Contributors to OpRisk PeopleRisk Process Risk – Transaction Risk – Documentation/contract risk. – Operational Control Risk – Model Risk Systems Risk – Technology Risk– MIS Risk. Legal and Regulatory Risk Event Risk 6
- 7. OpRisk Management process Appropriatepolicies and procedures Efforts to identify and measure operational risk Effective monitoring and reporting A sound system of internal controls, and Appropriate testing and verification of the Operational Risk Framework 7
- 8. Concept of GrossIncome The Basel Committee has allowed each relevant national supervisor to define gross income. RBI defines gross income as follows, Gross income = Net profit (+) Provisions & Contingencies (+) operating expenses (Schedule 16) (-) profit on sale of HTM investments (-)income from insurance (-) extraordinary / irregular item of income (+) loss on sale of HTM investments 8
- 9. Computation of CapitalCharge Standardized Capital change based on single risk indicator Foundation Operational Capital based on business Risk lines and industry standards Advanced Capital based on business lines and internally calculated standards 10
- 10. OpRisk Approaches Approach Calculation of Capitalcharge Basic Indicator • Average of Gross Income for three years as indicator • Capital charge equals 15% of the indicator Standardized • Gross income per regulatory line as indicator • Depending on business line 12, 15 or 18 % of the indictor as capital charge • Total capital charge equals sum of charge per business line Advanced Measurement • Capital charge equals internally generated measures based on, Internal loss data External loss data Scenario analysis Business environment and internal control factors • Recognition of risk mitigation (upto 20%) 11
- 11. Approach Qualifying criteria OpRisk Approaches Basic Indicator •No specific criteria • Compliance with the Basel Committee’s “Sound Practices for the Management and Supervision of Operational Risk” recommended Standardized • Active involvement of Board of directors and Senior management • Existence of OpRisk Management function • Sound OpRisk Management system • Systematic tracking of loss data Advanced Measurement Same as standardized plus • Measurement integrated into day-to-day risk management • Review of management and measurement processes by internal/extern al auditor • Numerous quantitative standards—in particular 3-5 years of historic data 12
- 12. Standardized Approach--Capital Charge Corporate financeGross income b1 Trading and sales Gross income b2 Retail banking Gross income b3 Commercial banking Gross income b4 Payment and settlement Gross income b5 Agency services Gross income b6 Asset management Gross income b7 Retail brokerage Gross income b8 18 18 12 15 18 15 12 12 13
- 13. Recognizing/Assessing Risk Events (i)Experience - The event has occurred in the past (ii) Judgment - Business logic suggests that it is a risk (iii) Intuition - Events where appropriate measures saved the institution in the nick of time (iv) Linked Events - This event resulted in a loss resulting from other risk type (credit, market etc.) (v) Regulatory requirement ASSESSMENT Self assessment Risk mapping Key Risk indicators 14
- 14. Factors: Assessing Potentialrisk areas (i) Staff related factors such as productivity, expertise, turnover (ii) Extent of activity outsourced (iii) Process clarity, complexity, changes (iv) IT Indices (v) Audit Scores (vi) Expected changes or spurts in volumes 15
- 15. Risk Measurement: Basis (i)Total number of risk events (ii) Total financial reversals (iii) Net financial impact (iv) Exposure: Based on expected increase in volumes (v) Total number of customer claims paid out (vi) IT indices: Uptime etc. (vii) Office Accounts Status: such as changes in balances 16
- 16. Monitoring Operational Risk--Issues Operationalloss events Identification of appropriate indicators Frequency of monitoring and reporting MIS Business line identification Corporate finance, Trading and sales, Retail banking, Commercial banking, Payment and settlement , Agency services, Asset management, and Retail brokerage. 17
- 17. OpRisk Management &Data Needs Data Types Transactional Operational/CRM Analytical Risk management Economy/Industry Data Collected Loss Event Data Causal Data Loss Effect Key Risk Indicators (KRIs) Proxies Risk Inventories Structured Self Assessment Data External Data 18
- 18. Management tasks Decision whethercontrol for risk minimization or bear Risk mitigation tools as complementary to control Investment in technology and Information security Outsourcing policy-- development and adoption Impact of operational break downs and loss--intra and outside bank Business Continuity plans and testing Review of Business Continuity plans 19
- 19. Organisational Set-up Board ofDirectors Risk Management Committee of the Board Operational Risk Management Committee Operational Risk Management Department Operational Risk Managers Support Group for operational risk management 20
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