Source: E-mail dt. 3 June 2015
Operational Risk Management in Indian Commercial Banking Sector - A Case Study
R. Lumina Julie
Asst Professor, Department of Management Studies,
Kathir College of Engineering and Research Scholar in Anna University,
Coimbatore, Tamilnadu, India.
The conventional definition of management is getting work done through people, but real management is developing people through work.”
Operational risk is the risk of some adverse outcome resulting from acts undertaken (or neglected) in carrying out business activities, inadequate or failed internal processes and information systems, misconduct by people or from external events and shocks. Operational risk is a generic risk present in operations which exists even before any deposit is accepted or a credit is granted by a bank. Unlike other banking risks, viz, credit and market risk which have a broader consensus on their conceptual understanding in the industry worldwide, operational risk is considered as a risk characterized by idiosyncrasy. Since last two decades, financial institutions worldwide have been seen placing increased emphasis on the management and measurement of operational risk. Modern approach of Operational Risk management which particularly stresses its measurement and linkage with the bank capital adequacy is considered as a new frontier of value creation and efficiency in banks. The need of an explicit capital charge to address a banks‟ operational risk exposure has been felt by the Basel Committee of Banking Supervision (BCBS), as many banking institutions in the developed countries were shaken by mega operational failures emanating from events of fraud, technological failure or due to control breakdowns resulting in collapse of age old financial institutions like, Barings Bank of UK, Daiwa of Japan etc.
Objectives and Scope of the study
The present study was conducted with the following objectives:
1. To access and analyze the present framework and management practices of the selected Bank towards operational risk and;
2. To examine and summarize the overall progress made by the Bank in the area of ORM at the Bank under study given the regulatory necessities.
The study remained restricted to the analysis of perception and framework of the management of Operational Risk at the Bank. Operational risk management, a new and emerging area in banks everywhere particularly in Indian Banks, the current study restricted its scope to survey top executives and the risk professionals of the bank only to assess the present status and framework of operational risk in the selected organization.
1. Operational risk management is older than credit risk and market risk management as Buchelt and Unteregger (2004) argue that long before the advent of Basel II, financial institutions had put in place various control mechanisms and procedures. The process of managing operational risk is different from those of managing market risk and credit risk only in so far as operational risk is different from the other two kinds of risk.
2. Netter and Poulsen (2003) emphasis that either due to new regulations or the increasing level of operational risk in financial services, banks have to focus on development of sophisticated ways for measurement of operational risk, besides integration of market and credit risk into its analysis in the coming years.
3. Harris (2002a) provides a basic overview of what advanced financial organizations are doing to address operational risk that summarizes the implementation of operational risk management. He identifies this pattern: recognizing operational risk as a separate discipline, restructuring the organizational hierarchy, defining a management process, creating measurement tools, developing monitoring systems.
To achieve the aforementioned objectives of the study, information was obtained by interviewing the respondents through a structured interview schedule. In order to make the interview schedule exhaustive and meaningful, both open ended and close ended questions have been included. Before the final administration, the interview schedule has been duly modified and improved after making it subject to opinion and advice of academic experts and risk professionals from the bank. The research is a case study type, as such it may mainly rely on the primary data to be collected from the organization itself. Convenience sampling technique is chosen to select the respondents keeping in view size and characteristics of the population.
Results of the Study
The interview schedule investigates the problem on the basis of following operational risk management dimensions:
1. General Background of Operational Risk Function: This dimension tries to investigate general level of understanding of the operational risk management and the key operational risks being faced by the bank. The outcome of survey shows that respondents on an average ranked technology and infrastructure deficiencies, difficulty in demonstrating cost-benefit analysis, lack of skilled or professionally qualified people as highly significant limitations to the progress of operational risk management in the bank.
2. Organizational Structure: Under this dimension, various questions have been raised to find out whether there is an adequate organization framework suitable to the size and complexity of the bank to take care of its exposure of Operational Risk.
3. Data Quantification and Modeling: This dimension assesses the current status and progress made by bank in operational risk measurement. It also investigates whether the operational risk measurement models are put to proper periodical validation.
4. Contingency Planning: Under this dimension, bank‟s disaster management and recovery plans will be investigated to understand how well they work and how often are they subject to review?
The state of affairs in respect of development of these two stages of ORM, knowledge and awareness and data quantification and modeling is generally observed in the whole banking industry in India. Lack of operational risk awareness is due to the reasons that operational risk though being very old banking risk, but the evolution as its quantification and explicit capital requirement are recent and banks have not been able to emphasize its understanding at the operative level. Until now, focus has been on the development of a global level risk management function to support ORM framework creation activity. There has been lack of stress on understanding and creation of awareness among the business unit level people about the issue of operational risk. This state has led to the problems in identification of operational risk, its documentation and finally the reporting for loss data aggregation. The bank under study also lacks adequate emphasis on training and creating awareness of operational risk among the people at ground level in terms of the new demands. Bank need to create linkages between risk management function, training departments, human resources wing and the business units in order to create mass awareness about the operational risk. Operational risk modeling is grounded in a rich operational risk loss data of atleast five years. Data collection is facing huge problems presently also due to the lack of proper understanding of operational risk at the reporting entity levels. This is what is hampering the progress in the stage of data quantification and risk modeling.
1.Basel Committee on Banking Supervision, BCBS, 2001a. “The new Basel Capital Accord: an explanatory note”. Report to the Bank for International Settlements, Centralbahnplatz 2, 4002 Basel, Switzerland (January) viewed on 10th January 2012, at: http://www.bis.org/publ/bcbsca01.pdf.
2.Buchelt, R. and S. Unteregger. 2004. “Cultural Risk and Risk Culture: Operational Risk after Basel II”. Financial Stability Report 6” viewed on 30th January 2012, at http://www.oenb.at/en/img/fsr 06 cultural risk tcm16–9495.pdf
3.Dardac Nicolae, Chiriac Petronel, 2010. “The Management of Operational Risk Specific to Non-banking Financial Institutions in the Context of Actual Financial Crisis”. Theoretical and Applied Economics, Volume XVII, No. 4(545), pp. 93-106.
4. Netter Jeffry M. Poulsen Annette B. 2003. “Operational Risk in financial service providers and the proposed Basel Capital Accord: An overview”. Advances in Financial Economics, Volume 8. Emerald Group Publishing Limited, pp. 147-171.
5.Sundmacher Maike, “The Basic Indicator Approach and the Standardised Approach to Operational Risk: An Example- and Case Study Based Analysis”, viewed on 5th December 2012 at: http://ssrn.com/abstract=988282.