Volume : 3 | Issue : 1 | January 2013 | ISSN - 2249-555X
Operational Risk Management in Banking Sector: An overview
Assistant, State Bank of India Margheita-786181 Dist.-Tinsukia Assam ABSTRACT Operational risk is inherent in all banking products, activities and processes and systems and the effective management of operational risk is of paramount importance for every bank’s board and senior management. With globalization and deregulation of financial markets, increased competition combined with the advent of high-end, innovative, sophisticated technology tremendous changes have taken place in the products distribution channels and service delivery mechanism of the banking sector. These have introduced more complexities into the banking operations and consequently the risk patterns and profiles of the industry have also become complex, diverse and catastrophic. The New Capital Adequacy Framework of the Reserve Bank of India requires bank to maintain capital explicitly towards operational risk. This paper tries to study the various methodologies used by the banks in their operational risk management activity and to study the regulatory framework related to operational risk management. Introduction Since the late 1990s, globalization, deregulation, consolidation, outsourcing, breaking of geographical barriers by use of sophisticated technology, growth of e-commerce etc. have significantly changed the business, economic and regulatory climate of the banking sector. These developments introduced more complexities into the activities of banks and their risk profiles. Consequently a series of high profile operational loss events at Societe Generale, UBS, AIB, and National Australia Bank etc. have led banks and their managements world over to increasingly view operational risk management as an integral part of their risk management activity like the management of market risk and credit risk. The identification and measurement of operational risk is a significant issue for modern-day banks, particularly since the decision by the Basel Committee on Banking Supervision (BCBS) to introduce a capital charge for this risk as part of the new capital adequacy framework (Basel II). Operational risk has been defined by the Basel Committee on Banking Supervision as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition is based on the underlying causes of operational risk. It seeks to identify the causes of a loss event and at the broadest level includes the breakdown by four causes: people, processes, systems and external factors. Operational risk may materialise directly, e.g., in electronic fund transfer (transfer of funds to the wrong person) or could result indirectly as a credit or market loss. Since there is a close linkage of operational risk with other types of risks, it is very important for banks to first have a clear understanding of the concept of operational risk before designing the appropriate operational risk measurement and management framework. Different types of operational risk in Banking Sector The Basel Committee has identified the following types of operational risk events as having the potential to result in substantial losses for banks: • Internal fraud. For example, intentional misreporting of positions, employee theft, and insider trading on an employee’s own account. • Externalfraud.Forexample,robbery,forgery,chequekiting, and damage from computer hacking. • Employment practices and workplace safety. For example, workers compensation claims, violation of employee health and safety rules, organised labour activities, discrimination claims, and general liability. • Clients, products and business practices. For example, fiduciary breaches, misuse of confidential customer information, improper trading activities on the bank’s account, money...