Operational Risk

Operational Risk Definition: Risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems. The failure may be due to external events also. Excludes “Business Risk” and “Strategic Risk”.

Operational Risk Basel I defined operational risk as, Risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events. Basel II, defined operational risk as, Risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. For emergence of such a risk four causes have been mentioned and they are People, Process, Systems and External factors.

Components of Operational Risk Transaction Processing Risk Information Technology Security Risk Legal Risk Compliance Risk Human Resources Risk

Components of Business Risk not Included in Operational Risk Strategic Risk Reputation Risk Treasury Risk Tax Risk

People Risk Lack of key personnel, Lack of adequate training/experience of dealer (measured in terms of opportunity cost/employee turnover), Unauthorised access to the dealing room, Tampering voice recorders, Nexus between the front and back offices.

Process Risk Wrong reporting of important market developments to the Management resulting in faulty decision making Errors in entry of data in deal slips Non-monitoring of exposure in positions Loss of interest owing to the liquidity beyond prescribed limits

Process Risk Wrong reporting of important market developments to the management resulting in Non-revision of rates in cases of volatility Non-monitoring of closing and opening positions Wrong funding of accounts (wrong currency) Lack of policies in respect of new products

Systems Risk Losses due to systems failure. Not maintaining secrecy of system passwords. Technology investment not made adequately. Failure in systems development. Lacuna in systems implementation. Wrong judgment of system capacity.

External Risk Legal and regulatory risk Failure to enforce criminal proceedings Outsourcing risk Supplier risk Infrastructure utilities failure Treasury activities not complying with the regulatory requirement Statutory obligation being not met Political risk Government risk

Operational Loss Risk management focuses on large losses. Historically large losses have been associated with credit risk and market risk. Large losses also have a tendency to originate from business and operational failures. Improving and stabilizing earnings for shareholders has to focus on controlling operational risk losses.

Operational Risk Loss Types Legal Loss: customer, employee and other third party law suits. 2 . Regulatory Compliance Loss: Fines for non disclosure, cost of license revocations and other costs. 3 . Assets Loss: Reduction in value non-financial asset such as property.

Operational Risk Loss Types 4 . Customer Compensarion: Compensation payments (principal and/or interest) or other compensatory payments to customers. 5 . Fraud and Unauthorized Activities: Rogue trading, Unauthorized loan sanctions. 6. Process Loss: Late settlement, wrong counterparty deals. 13