Operational Risk Management In Banks Essay Sample

Hazard is built-in in any walk of life in general and in fiscal sectors in peculiar. Till late. due to regulated environment. Bankss could non afford to take hazards. But of late. Bankss are exposed to same competition and hence are compelled to encounter assorted types of fiscal and non-financial hazards. Hazards and uncertainnesss form an built-in portion of banking which by nature entails taking hazards. There are three chief classs of hazards ; Credit Risk. Market Risk & A ; Operational Risk. OPERATIONAL Hazard

Always Bankss live with the hazards originating out of human mistake. fiscal fraud and natural catastrophes. The occurrences such as WTC calamity. Denudations fiasco etc. has highlighted the possible losingss on history of operational hazard. Exponential growing in the usage of engineering and increase in planetary fiscal inter-linkages are the two primary alterations that contributed to such hazards. Operational hazard. though defined as any hazard that is non categorized as market or recognition hazard. is the hazard of loss originating from unequal or failed internal procedures. people and systems or from external events.

In order to extenuate this. internal control and internal audit systems are used as the primary agencies. Hazard instruction for familiarising the complex operations at all degrees of staff can besides cut down operational hazard. Insurance screen is one of the of import mitigators of operational hazard.

Operational hazard events are associated with weak links in internal control processs. The key to direction of operational hazard lies in the bank’s ability to measure its procedure for exposure and set up controls every bit good as precautions while supplying for unforeseen worst-case scenarios.

Operational hazard involves breakdown in internal controls and corporate administration taking to error. fraud. public presentation failure. via media on the involvement of the bank ensuing in fiscal loss. Puting in topographic point proper corporate administration patterns by itself would function as an effectual hazard direction tool. Bank should endeavor to advance a shared apprehension of operational hazard within the organisation. particularly since operational hazard is frequently interwined with market or recognition hazard and it is hard to insulate.

Definition of operational hazard has evolved quickly over the past few old ages. At first. it was normally defined as every type of unquantifiable hazard faced by a bank. However. farther analysis has refined the definition well. Operational hazard has been defined by the Basel Committee on Banking Supervision1 as the hazard of loss ensuing from inadequate or failed internal procedures. people and systems or from external events. This definition includes legal hazard. but excludes strategic and reputational hazard. This definition is based on the implicit in causes of operational hazard. It seeks to place why a loss happened and at the broadest degree includes the dislocation by four causes: people. procedures. systems and external factors. Likely signifiers of manifestation of operational hazard

A clear grasp and apprehension by Bankss of what is meant by operational hazard is critical to the effectual direction and control of this hazard class. It is besides of import to see the full scope of material operational hazards confronting the bank and gaining control all important causes of terrible operational losingss.

Operational hazard is permeant. complex and dynamic. Unlike market and recognition hazard. which tend to be in specific countries of concern. operational hazard is built-in in all concern procedures. Operational hazard may attest in a assortment of ways in the banking industry.

The Basel Committee has identified the undermentioned types of operational hazard events as holding the possible to ensue in significant losingss: * Internal fraud – For illustration. knowing misreporting of places. employee larceny. and insider trading on an employee’s ain history. * External fraud – For illustration. robbery. counterfeit. check kiting. and harm from computing machine choping. * Employment patterns and workplace safety – For illustration. workers compensation claims. misdemeanor of employee wellness and safety regulations. organized labour activities. favoritism claims. and general liability.

* Clients. merchandises and concern patterns – For illustration. fiducial breaches. abuse of confidential client information. improper trading activities on the bank’s history. money laundering. and sale of unauthorised merchandises. * Damage to physical assets – For illustration. terrorist act. hooliganism. temblors. fires and inundations. * Business break and system failures – For illustration. hardware and package failures. telecommunication jobs. and public-service corporation outages. * Execution. bringing and procedure direction – For illustration: informations entry mistakes. indirect direction failures. uncomplete legal certification. and unauthorised entree given to client histories. non-client counterparty mis-performance. and seller differences. Relevance of Operational hazard map

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Turning figure of high-profile operational loss events worldwide have led Bankss and supervisors to progressively see operational hazard direction as an built-in portion of hazard direction activity. Management of specific operational hazards is non a new pattern ; it has ever been of import for Bankss to seek to forestall fraud. keep the unity of internal controls. and cut down mistakes in dealing processing. and so on. However. what is comparatively new is the position that operational hazard direction is a comprehensive pattern comparable to the direction of recognition and market hazards.

Operational Risk differs from other banking hazards in that it is typically non straight taken in return for an expected wages but is inexplicit in the ordinary class of corporate activity and has the possible to impact the hazard direction procedure. However. it is recognized that in some concern lines with minimum recognition or market hazards. the determination to incur operational hazard. or vie based on the sensed ability to pull off and efficaciously monetary value this hazard. is an built-in portion of a bank’s hazard / wages concretion. At the same clip. failure to decently pull off operational hazard can ensue in a misstatement of an institution’s hazard profile and expose the establishment to important losingss. ‘Management’ of operational hazard is taken to intend the ‘identification. appraisal and / or measuring. monitoring and control / mitigation’ of this hazard. Organizational set up and civilization

Operational hazard is intrinsic to a bank and should therefore be an of import constituent of its endeavor broad hazard direction systems. The Board and senior direction should make an enabling organisational civilization puting high precedence on effectual operational hazard direction and attachment to sound operating processs. Successful execution of hazard direction procedure has to emanate from the top direction with the presentation of strong committedness to incorporate the same into the basic operations and strategic determination devising procedures. Therefore. Board and senior direction should advance an organisational civilization for direction of operational hazard.

It is recognized that the attack for operational hazard direction that may be chosen by an single bank will depend on a scope of factors. including size and edification. nature and complexness of its activities. However. despite these differences. clear schemes and inadvertence by the Board of Directors and senior direction ; a strong operational hazard civilization. i. e. . the combined set of single and corporate values. attitudes. competences and behavior that determine a bank’s committedness to and manner of operational hazard direction ; internal control civilization ( including clear lines of duty and segregation of responsibilities ) ; effectual internal coverage ; and eventuality planning are all important elements of an effectual operational hazard direction model.

Ideally. the organisational set-up for operational hazard direction should include the undermentioned:
* Board of Directors
* Risk Management Committee of the Board
* Operational Risk Management Committee
* Operational Risk Management Department
* Operational Hazard Directors
* Support Group for operational hazard direction
Designation of operational hazard
Banks should place and measure the operational hazard inherent in all stuff merchandises. activities. procedures and systems. Banks should besides guarantee that earlier new merchandises. activities. procedures and systems are introduced or undertaken. the operational hazard inherent in them is identified clearly and subjected to adequate appraisal processs.

Hazard designation is paramount for the subsequent development of a feasible operational hazard monitoring and control system. Effective hazard designation should see both internal factors ( such as the bank’s construction. the nature of the bank’s activities. the quality of the bank’s human resources. organisational alterations and employee turnover ) and external factors ( such as alterations in the industry and technological progresss ) that could adversely impact the accomplishment of the bank’s aims.

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The first measure towards placing hazard events is to name out all the activities that are susceptible to operational hazard. To get down with. we can name: * The chief concern groups viz. corporate finance. trading and gross revenues. retail banking. commercial banking. payment and colony. bureau services. plus direction. and retail securities firm. * The analysis can be farther carried out at the degree of the merchandise squads in these concern groups. e. g. dealing banking. trade finance. general banking. hard currency direction and securities markets. * Thereafter the merchandise offered within these concern groups by each merchandise squad can be analyzed. e. g. import measures. missive of recognition. bank warrant under trade finance.

After the merchandises are listed. the assorted operational hazard events associated with these merchandises are recorded. An operational hazard event is an incident/experience that has caused or has the possible to do material loss to the bank either straight or indirectly with other incidents. Hazard events are associated with the people. procedure and engineering involved with the merchandise. They can be recognized by: ( I ) Experience – The event has occurred in the yesteryear ;

( two ) Judgment – Business logic suggests that the bank is exposed to a hazard event ; ( three ) Intuition – Events where appropriate steps saved the
establishment in the dent of clip ; ( four ) Linked Events – This event resulted in a loss ensuing from other hazard type ; ( V ) Regulatory demand – regulator requires acknowledgment of specified events. Assessment of Operational Risk

In add-on to placing the hazard events. Bankss should measure their exposure to these hazard events. Effective hazard appraisal allows a bank to better understand its hazard profile and most efficaciously aim hazard direction resources. Amongst the possible tools that may be used by Bankss for measuring operational hazard are: * Self Risk Assessment: A bank assesses its operations and activities against a bill of fare of possible operational hazard exposures. This procedure is internally driven and frequently incorporates checklists and/or workshops to place the strengths and failings of the operational hazard environment. Scorecards. for illustration. supply a agency of interpreting qualitative appraisals into quantitative prosodies that give a comparative ranking of different types of operational hazard exposures. Some tonss may associate to put on the line alone to a specific concern line while others may rank hazards that cut across concern lines.

Tonss may turn to built-in hazards. every bit good as the controls to extenuate them. * Hazard Function: In this procedure. assorted concern units. organisational maps or procedure flows are mapped by hazard type. This exercising can uncover countries of failing and aid prioritise subsequent direction action. * Key Risk Indexs: Key hazard indexs are statistics and/or prosodies. frequently fiscal. which can supply insight into a bank’s hazard place. These indexs should be reviewed on a periodic footing ( such as monthly or quarterly ) to alarm Bankss to alterations that may be declarative of hazard concerns. Such indexs may include the figure of failed trades. staff turnover rates and the frequence and/or badness of mistakes and skips. Monitoring of Operational Risk

An effectual monitoring procedure is indispensable for adequately pull offing operational hazard. Regular monitoring activities can offer the advantage of rapidly observing and rectifying lacks in the policies. procedures and processs for pull offing operational hazard. Promptly observing and turn toing these lacks can well cut down the possible frequence and/or badness of a loss event.

In add-on to supervising operational loss events. Bankss should place appropriate indexs that provide early warning of an increased hazard of future losingss. Such indexs ( frequently referred to as early warning indexs ) should be advanced and could reflect possible beginnings of operational hazard such as rapid growing. the debut of new merchandises. employee turnover. dealing interruptions. system downtime. and so on. When thresholds are straight linked to these indexs. an effectual monitoring procedure can assist place cardinal stuff hazards in a crystalline mode and enable the bank to move upon these hazards suitably.

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The frequence of monitoring should reflect the hazards involved and the frequence and nature of alterations in the operating environment. Monitoring should be an incorporate portion of a bank’s activities. The consequences of these monitoring activities should be included in regular direction and Board studies. as should compliance reappraisals performed by the internal audit and/or hazard direction maps. Reports generated by ( and/or for ) intermediary supervisory governments may besides inform the corporate monitoring unit which should similarly be reported internally to senior direction and the Board. where appropriate. Senior direction should have regular studies from appropriate countries such as concern units. group maps. the operational hazard direction unit and internal audit.

The operational hazard studies should incorporate internal fiscal. operational. and conformity informations. every bit good as external market information about events and conditions that are relevant to determination devising. Reports should be distributed to appropriate degrees of direction and to countries of the bank on which countries of concern may hold an impact. Reports should to the full reflect any identified job countries and should actuate seasonably disciplinary action on outstanding issues. To guarantee the utility and dependability of these hazard studies and audit studies. direction should regularly verify the seasonableness. truth. and relevancy of describing systems and internal controls in general. Management may besides utilize studies prepared by external beginnings ( hearers. supervisors ) to measure the utility and dependability of internal studies. Reports should be analyzed with a position to bettering bing hazard direction public presentation every bit good as developing new hazard direction policies. processs and patterns. The ORM Process Summary

The ORM procedure comprises six stairss. each of which is every bit of import:

Measure 1: Identify the Hazard
A jeopardy is defined as any existent or possible status that can do debasement. hurt. unwellness. decease or harm to or loss of equipment or belongings. Experience. common sense. and specific analytical tools help place hazards. Measure 2: Buttocks the Hazard

The assessment measure is the application of quantitative and qualitative steps to find the degree of hazard associated with specific jeopardies. This procedure defines the chance and badness of an accident that could ensue from the jeopardies based upon the exposure of worlds or assets to the jeopardies.

Measure 3: Analyze Risk Control Measures
Investigate specific schemes and tools that cut down. mitigate. or extinguish the hazard. All hazards have three constituents: chance of happening. badness of the jeopardy. and the exposure of people and equipment to the hazard. Effective control measures cut down or extinguish at least one of these. The analysis must take into history the overall costs and benefits of remedial actions. supplying alternate picks if possible. Measure 4: Make Control Decisions

Identify the appropriate decision-maker. That decision-maker must take the best control or combination of controls. based on the analysis of measure 3. Measure 5: Implement Hazard Controls Management must explicate a program for using the controls that have been selected. so supply the clip. stuffs and forces needed to set these steps in topographic point. Measure 6: Supervise and Review

Once controls are in topographic point. the procedure must be sporadically reevaluated to guarantee their effectivity. Workers and directors at every degree must carry through their several functions to guarantee that the controls are maintained over clip. The hazard direction procedure continues throughout the life rhythm of the system. mission or activity. Decision

Operational hazard direction provides a logical and systematic agencies of placing and commanding hazard. Operational hazard direction is non a complex procedure. but does necessitate persons to back up and implement the basic rules on a go oning footing. Operational hazard direction offers persons and organisations a powerful tool for increasing effectivity and cut downing accidents. The ORM procedure is accessible to and useable by everyone in every imaginable scene or scenario. It ensures that all FAA forces will hold a voice in the critical determinations that determine success or failure in all our operations and activities. Properly implemented. ORM will ever heighten public presentation.