Operational risk is "the risk of a change in value caused by the fact that the actual losses arising from inadequate or failed internal processes, people and systems, or external events (including legal risks), are different from expected loss ". This definition, adopted by the European Union Solvency II Directive for insurance companies, is a variation of that adopted in Basel II regulations for banks. In October 2014, the Basel Committee on Banking Supervision proposed a revision of its operational risk capital framework which established a new standard approach to replace basic indicator approaches and a standardized approach for calculating operational risk capital.
It may also include other risk classes, such as fraud, security, privacy protection, legal, physical risks (eg closure of infrastructure) or environmental risks.
The operational risk study is a broad discipline, close to good management and quality management.
In the same way, operational risk affects client satisfaction, reputation and shareholder value, all while increasing business volatility.
Contrary to other risks (eg credit risk, market risk, insurance risk) operational risks are usually not voluntary or driven by income. In addition, they can not be diversified and can not be dismissed, which means that, as long as people, systems and processes remain imperfect, operational risks can not be completely eliminated.
Operational risk, however, can be managed to keep losses in some degree of risk tolerance (ie the amount of risk prepared to receive in pursuit of its objectives), determined by balancing the cost of improvements to expected benefits.
Broader trends such as globalization, the expansion of the Internet and the rise of social media, as well as increased demands for greater corporate accountability around the world, reinforce the need for sound operational risk management.
Video Operational risk
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Until Basel II's reforms for banking supervision, operational risk is a residual category provided for uncertainty and risk that is difficult to measure and manage in a traditional way - the "other" risk basket.
The regulation institutionalizes operational risk as a category of regulatory and managerial concerns and links operational risk management with good corporate governance.
Of course, business in general, and other institutions such as the military, have been aware, for years, the dangers arising from operational, internal or external factors. The main purpose of the military is to fight and win the war in a quick and decisive way, and with minimal losses. For the military and business world alike, operational risk management is an effective process for conserving resources with anticipation.
Two decades (from the 1980s to early 2000s) globalization and deregulation (eg Big Bang (financial markets)), combined with increasing sophistication of financial services worldwide, have introduced additional complexity into the activities of banks, insurance companies and corporations in risk profiles general and therefore.
Since the mid-1990s, the topic of market risk and credit risk has been the subject of debate and research, with the result that financial institutions have made significant advances in the identification, measurement and management of these two forms of risk.
However, the near collapse of the US financial system in September 2008 is an indication that our ability to measure market and credit risk is far from perfect and ultimately leads to the introduction of new regulatory requirements around the world, including Basel III rules for banks and Solvency II regulation for insurance.
Events such as the September 11 terrorist attacks, naughty trade losses at Socià © à © gÃÆ'  © nÃÆ' © rale, Barings, AIB, UBS and National Australia Bank serve to highlight the fact that the scope of risk management extends beyond just the market and credit risk.
These reasons underscore the focus of banks and regulators on the identification and measurement of operational risks.
The list of risks (and, more importantly, the scale of these risks) faced by banks today includes fraud, system failure, terrorism, and employee compensation claims. These types of risks are generally classified under the term 'operational risk'.
The identification and measurement of operational risk is a real and living issue for modern banks, especially since the decision by the Basel Committee on Banking Supervision (BCBS) to introduce the capital cost for this risk as part of the new capital adequacy framework (Basel II).
Maps Operational risk
Definitions
The Basel II Committee defines operational risk as:
"The risk of loss resulting from inadequate or failed internal processes, people and systems or external events."
However, the Basel Committee recognizes that operational risk is a term that has multiple meanings and therefore, for internal purposes, banks are allowed to adopt their own operational risk definition, provided that the minimum elements in the definition of the Committee are included.
Exclude coverage
Basel II's definition of operational risk excludes, for example, strategic risks - the risk of loss arising from poor strategic business decisions.
Other risk terms are seen as potential consequences of operational risk events. For example, reputation risk (damage to the organization due to loss of reputation or position) may arise as a consequence (or impact) of operational failure - as well as from other events.
Basel II seven categories of event types
Here is a list of seven types of official Basel II events with examples for each category:
- Internal Cheating - asset misuse, tax evasion, deliberate positioning mismarking, bribery
- External Cheating - information theft, hacking hack, third party theft and counterfeiting
- Workplace Safety and Safety Practices - employee discrimination, workers compensation, employee health and safety
- Clients, Products, and Business Practices - market manipulation, antitrust, undue trade, product defects, fiduciary infringement, account milling
- Damage to Physical Assets - natural disasters, terrorism, vandalism
- Business Disruptions and System Failures - utility interruptions, software failures, hardware failures
- Execution, Delivery, and Process Management - data entry errors, accounting errors, mandatory reporting failed, negligent loss of client assets
Difficulty
It is relatively easy for an organization to establish and observe specific and measurable levels of market risk and credit risk as there are models trying to predict the potential impact of market movements, or changes in the cost of credit. It should be noted, however, that these models are only as good as the underlying assumptions, and most recent financial crises arise because the valuations generated by these models for certain types of investments are based on false assumptions.
On the contrary, it is relatively difficult to identify or assess the level of operational risk and its many sources. Historically the organization has accepted operational risk as an unavoidable cost of doing business. Many now though collect operational loss data - eg through system failure or fraud - and use this data to model operational risk and calculate capital reserves against future operating losses. In addition to the Basel II requirements for banks, this is now a requirement for European insurance companies that are in the process of implementing Solvency II, equivalent to Basel II for the insurance sector.
Method to calculate operational risk capital
Basel II and various regulatory bodies of countries have established various health standards for operational risk management for banks and similar financial institutions. To complement these standards, Basel II has provided guidance on three broad modal calculation methods for operational risk:
- Basic Indicator Approach - based on the Financial Institution's annual income
- The Standard Approach - based on annual revenues from each of the broad business lines of the Financial Institution
- The Advanced Measurement Approach - based on an internally developed risk measurement framework of banks that follow the specified standards (methods include IMA, LDA, Scenario based, Scorecard etc.)
The operational risk management framework should include identification, measurement, monitoring, reporting, control and mitigation frameworks for operational risk.
Source of the article : Wikipedia
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