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operations risk management power point presentation.
Operational risk can result in losses from internal failures or external events. It is classified based on frequency and impact of events. Management typically focuses on low frequency/high impact events and high frequency/low impact events. The Basel Accords define three approaches to operational risk capital requirements: Basic Indicator, Standardized, and Advanced Measurement. The Standardized Approach divides business activities into eight lines and assigns a beta multiplier to each line's gross income. The Advanced Measurement Approach uses banks' internal models to calculate regulatory capital.
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operations risk management power point presentation.
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- 2. What is OperationalRisk? The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events (The Basel II Capital Accord) FORMERLY any risk but market and credit risks It is NOT a brand new stuff and it is the risk that affects all businesses Operational risk is inherent in carrying out a process/ operational activity. 07/03/20 14 2
- 3. Classification of OperationalRisks High Frequency Frequency High Frequency Low Impact Low Low Frequency Frequency Low High Impact Operational risk events are classified by two factors: High Impact Impact frequency – how often the event occurs impact – the amount of the losses resulting from the event Impact 07/03/2014 3
- 4. Classification of OperationalRisks Generally, operational risk management focuses on only two of these event types: Low frequency / high impact (LFHI) High frequency / low impact (HFLI) Why? 07/03/20 14 4
- 5. Classification of Operational Risks Highfrequency/low impact events are managed to improve business efficiency. These events tend to be readily understood and are viewed as ‘the cost of doing business’. Examples? 07/03/20 14 5
- 6. Expected loss versesunexpected loss Expected loss is the loss incurred as a bank conducts its normal business. Can be simply defined as the cost of doing business The only way to totally prevent them is to cease doing business. 07/03/20 14 6
- 7. Expected loss versus unexpectedloss A bank uses statistical methods to predict its expected losses. In short, the firm uses past data and experience to predict the future. A simple method of calculating expected loss is to compute the mean (average) of the actual losses over a given time and accept this as the likely future level. 07/03/20 14 7
- 8. Expected loss versesunexpected loss A firm may also attempt to ‘predict’ its unexpected losses using statistics, much like the way that is used to predict expected losses. The problems are the past data may not available and therefore to calculate unexpected loss a firm uses: available internal data external data from other firms data from operational risk scenarios 07/03/20 14 8
- 9. Operational risk event categories Thesimplest way of understanding operational risk in banks is to categorize it as anything but credit risk or market risk. However, this is a very broad definition and does not help manage operational risk. Generally, operational risk events can be subdivided into: internal process risk people risk systems risk external risk legal risk 07/03/20 14 9
- 10. Internal Process Risk Internalprocess risk is defined as the risk associated with the failure of a bank’s processes or procedures. During a bank’s day-to-day operations, staff follow preset working practices. These procedures and policies will include all the checks, and controls required to ensure that customers are correctly served and the bank remains within the laws and regulations by which it is governed 07/03/20 14 10
- 11. Internal Process Risks Internalprocess risk events include: lack of controls marketing errors misselling money laundering incorrect or insufficient reporting (e.g. regulatory) documentation – inadequate, insufficient or wrong transaction error Reviewing and improving a bank’s internal processes as part of operational risk management can improve its efficiency. Errors often occur when a process is complicated, disorganized or easily circumvented, all of which are also inefficient business practices. 07/03/20 14 11
- 12. Risk Management ProcessFeedback Loop 1. Identify, assess and prioritize risks 6. Revise policies and procedures 2. Develop strategies to measure risk 5. Test effectiveness and evaluate results 3. Design policies and procedures to mitigate risks 4. Implement and assign responsibility 07/03/20 14 12
- 13. There are fourfundamental steps to managing operational risk, with each step leading to improvements in management & control quality and greater economic profit REPORTING • Integrated MIS reporting Economic Profit MEASUREMENT PROCESSES • Loss data collection FRAMEWORK • Risk indicator data collection • Risk strategy, tolerance • Control selfassessment • Roles and responsibilities • Estimation of scores representing quality of internal controls • Workflow • Risk definition and categorization • Estimation of VaR – risk capital • Risk assessment and analysis • Policies and procedures • Estimation of annual losses – cost of operational failure • Follow up action • Automatic notification Management & Control Quality • Awareness of exposures • Knowledge of controls quality • Cost benefit analysis • Improved risk mitigation and transfer strategy
- 14. The universe ofoperational risks spans causes, events and consequences CAUSES EVENTS Inadequate segregation of duties Insufficient training Lack of management supervision Inadequate auditing procedures Inadequate security measures • • • Poor systems design CONSEQUENCES Legal Liability Internal Fraud Regulatory, Compliance & Taxation Penalties External Fraud Loss or Damage to Assets Employment Practices & Workplace Safety Restitution Clients, Products & Business Practices Loss of Recourse Damage to Physical Assets Write-down Business Disruption & System Failures Reputation Execution, Delivery & Process Management Business Interruption Poor HR policies EFFECTS Monetary Losses OTHER IMPACTS Forgone Income
- 15. Using internal andexternal loss data can calculate Value at Risk RISK MATRIX FOR LOSS DATA INDIVIDUAL LOSS EVENTS LOSS DISTRIBUTIONS 74,712,345 74,603,709 74,457,745 74,345,957 74,344,576 • INTERNAL FRAUD Corporate Finance Number Mean EXTERNAL FRAUD EMPLOYMENT PRACTICES & WORKPLACE SAFETY CLIENTS, PRODUCTS & BUSINESS PRACTICES DAMAGE TO PHYSICAL ASSETS EXECUTION, DELIVERY & PROCESS MANAGEMENT BUSINESS DISRUPTION AND SYSTEM FAILURES TOTAL 36 3 25 36 33 150 2 315 35,459 56,890 56,734 1,246 89,678 44,215 52,056 3,456 Standard Deviation 5,694 8,975 3,845 7,890 3,456 245 23,543 6,976 Number Mean Standard Deviation 50 53,189 8,541 4 78,084 13,463 35 5,184 5,768 50 85,335 11,835 46 85,101 5,184 210 1,869 368 3 134,517 35,315 441 66,322 10,464 Retail Banking Number 45 4 32 45 42 189 3 397 47,870 70,276 4,666 76,802 76,591 1,682 121,065 Mean 7,687 12,116 5,191 10,652 4,666 331 31,783 Number Mean Standard Deviation 41 43,083 6,918 3 63,248 10,905 28 4,199 4,672 41 69,121 9,586 37 68,932 4,199 170 1,514 298 2 108,959 28,605 37 3 26 37 34 153 2 3 4 321 38,774 56,923 3,779 62,209 62,039 1,363 98,063 48,349 Standard Deviation 6,226 9,814 4,205 8,628 3,779 268 25,744 7,628 Agency Services Number Mean Standard Deviation 44 46,529 7,472 4 68,308 11,777 31 4,535 5,045 44 74,651 10,353 40 74,446 4,535 184 1,635 321 2 117,675 30,893 386 58,018 9,154 Asset Management Number Mean • 2 357 53,721 8,476 Number 1 9,417 Commercial Banking 0 59,690 Standard Deviation Payment & Settlements 167,245 142,456 123,345 113,342 94,458 TOTAL LOSS DISTRIBUTION Frequency of events Trading & Sales • VAR CALCULATION 40 3 28 40 36 165 2 347 41,876 61,477 4,081 67,186 67,002 1,472 105,908 52,217 Standard Deviation 6,725 10,599 4,541 9,318 4,081 289 27,804 8,238 Retail Brokerage Number Mean Standard Deviation 48 50,252 8069 4 73,773 12719 33 4,898 5449 48 80,623 11182 44 80,402 4898 198 1,766 347 3 127,090 33365 417 62,660 9886 Insurance Number Mean 43 4 30 43 39 179 2 66,395 4,408 72,561 72,362 1,589 114,381 56,394 7,262 11,447 4,904 10,063 4,408 312 30,028 8,897 435 45,653 7,331 36 67,021 11,555 302 4,450 4,950 435 73,245 10,158 399 73,044 4,450 1,812 1,604 315 24 115,459 30,311 Severity of loss 375 45,226 Standard Deviation Number Mean Standard Deviation 3,806 56,926 8,981 Mean Total VaR Calculator e.g., Monte Carlo Simulation Engine Mean 99th Percentile Annual Aggregate Loss ($) 0-10 1020 2030 3040 4050
- 16. Composite control assessment/indicatorscores can be used to modify capital figures VAR CONTROL ASSESSMENT/INDICATOR SCORE CAPITAL Adjustment for Quality of Current Control Environment 210 190 100 Current score Previous score 50 0 Linking capital to changes in the quality of internal controls provides an incentive for desired behavioral change
- 17. What does ittell us? 07/03/20 14 17
- 18. Basel II Approacheson Operational Risk •Basic Indicator •Standardized •Advanced Measurement •OPERATIONAL •Standardized •Foundation IRB •Advanced IRB •CREDIT 07/03/20 14 18
- 19. The Basic IndicatorApproach Banks using the Basic Indicator Approach must hold capital for operational risk equal to the average over the previous three years of a fixed percentage (denoted alpha) of positive annual gross income. Figures for any year in which annual gross income is negative or zero should be excluded from both the numerator and denominator when calculating the average. 07/03/20 14 19
- 20. The charge maybe expressed as follows: 07/03/20 14 20
- 21. The Standardized Approach Inthe Standardized Approach, banks’ activities are divided into eight business lines: corporate finance, trading & sales, retail banking, commercial banking, payment & settlement, agency services, asset management, and retail brokerage. Within each business line, gross income is a broad indicator that serves as a proxy for the scale of business operations and thus the likely scale of operational risk exposure within each of these business lines. The capital charge for each business line is calculated by multiplying gross income by a factor (denoted beta) assigned to that business line. Beta serves as a proxy for the industry-wide relationship between the operational risk loss experience for a given business line and the aggregate level of gross income for that business line. It should be noted that in the Standardized Approach gross income is measured for each business line, not the whole institution, i.e. in corporate finance, the indicator is the gross income generated in the corporate finance business line 07/03/20 14 21
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- 25. Advanced Measurement Approaches(AMA) Under the AMA, the regulatory capital requirement will equal the risk measure generated by the bank’s internal operational risk measurement system using the quantitative and qualitative criteria. Use of the AMA is subject to supervisory approval. A bank adopting the AMA may, with the approval of its host supervisors and the support of its home supervisor, use an allocation mechanism for the purpose of determining the regulatory capital requirement 07/03/20 14 25
- 26. List of reference BaselII: Revised international capital framework. Bis.org. Retrieved 2013-06-06. Jump up Solvency - European Commission. Ec.europa.eu. 2012-11-26. Retrieved 2013-06-06 07/03/20 14 26