Operational Risk - A Primer

The Basle 2 Accord, first drafted in 1999, has justrelevant simplicity of market offerings. Many vendor
undergone its' final revision. The Act will haveofferings are centered on controlled self assessments
widespread ramifications on all institutions. One of the(CSA) and loss data capture tools, all of which can be
most notable changes from the original Basle Accorddeveloped internally. Whilst Self-Assessment is the
of 1988 is the introduction of a Capital Charge forright first step to take, it is just that, a first step.
Operational Risk. In respect of a charge being leviedAs the market matures there is strong evidence that
for losses (in excess of balance sheet reserves forthe current offerings for Ops Risk will be superceded
doubtful debts) the Financial Services market isby the need for automation, integration, visualization
unique. One does not see Capital Charges beingetc and an increase in focus away from CSA and the
applied to poor controls in manufacturing whererecording of losses to loss prevention.
margins are small and where errors of 1 in 1,000,000Survey results indicate that there is a substantial gap
can often be deemed excessive!between expectations and reality when it comes to
The need to include a Capital Charge specifically forthe short-term benefits of putting a risk
Operational Risk has raised the ire of many in themanagement framework in place. Many industry
industry who state that processes are in place toparticipants expect a reduction in losses and loss
minimize these effects, specifically as it relates toevents of over 20% for minimal investment!
Operational Resilience and Systemic failures.The Bank of International Settlements (BIS) has used
Indeed many in the Industry are of the opinion thatthe Basel Accord to force Financial Institutions to
Ops Risk should be relegated to a Pillar 2 charge,adopt the process quality control lessons that the
determined by each country's own regulators andmanufacturing sector have learnt over the past 30
that a combination of balance sheet reserves andyears.
other instruments such asIt is the authors' contention that the BIS intention in
1) Insurance policiesintroducing an Operational Risk Capital Charge is to
2) Commission chargesfocus senior management attention on the issue of
3) Surplus APRs on Credit CardsOperational Inefficiency and jump start an
As a result of the internal industry conflicts and theimprovement process.
nascent nature of Ops Risk as a risk category manyThe Spirit behind Basle 2 is to
institutions are taking a wait and see approach.1) Place focus of management on maximizing
However a more immediate regulatory issue hasoperational effectiveness and resilience whilst
pushed it to the fore, Sarbanes-Oxley.minimizing risk
One of the emerging trends is that, in Financial2) Highlight that the real purpose of operational risk
Institutions, Sarbanes-Oxley is seen as a subset ofmanagement programs, including loss data collection
Operational Risk and that many firms has merged theand capital modeling, is just to understand and better
two together.manage business better
Financial Institutions have spent relatively little onIn essence "Sound operational risk management is
external Operational Risk solutions, when comparedjust good business management practice".
to the spend on Market and Credit Risk, due to the