Strengthening Operational Risk Management Through Effective Loss Management

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Strengthening Operational Risk Management through Effective Loss Management MetricStream Webinar 28 November 2012
Patricia Jalleh Executive Director RiskBusiness International

Agenda • The importance of loss management • Critical success factors for managing loss events • Integrating loss management and operational risk management

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Basel Definition of Operational Risk Operational risk is defined as the risk of loss resulting from inadequate or failed Internal processes People Systems or from External Events. This definition includes legal risk and compliance risk but excludes strategic risk and reputational risk. 3

When is a Loss an Operational Risk Loss? When the underlying cause of the loss or harm is due to operational risk – i.e. Caused by inadequate or failed Internal processes People Systems or from External Events. Some credit risk and market risk losses have operational risk as the underlying root cause 4

How do Operational Risk Losses Happen? Internal Controls
Threats Threats Threats Threats Threats Threats

LOSSES
(Financial / Reputational)

Control Gaps / Weaknesses = Vulnerability

Risk Events or Losses occur when Threats successfully exploit Vulnerabilities 5

Loss Events, Causal Factors and Effects
Causal Factors 1. People Process Systems External Factors 6. 7. 5. 4. Basel 2 Event Categories Internal Fraud 2. External Fraud 3. Employment Practices & Workplace Safety Clients Products & Business Practices Effects Financial Loss Regulatory sanctions Legal suits Lost productivity Reputational Loss Loss of investor and customer confidence

Damage to Physical Assets

Business Disruption & System Failure

Execution Delivery and Process Management

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Importance of a Taxonomy for better loss analysis

• • • • • • • • • • •

Geography Legal Entity Business line Business function or customer segment Product/service category Process category Risk event category Risk causal category Risk impact category Control failure types Recovery type 7

Importance of Loss Management
• Assists in better management of operational risk Timely reporting and prompt damage control can help reduce the overall financial and reputational impact on the organisation Root cause analysis will help in implementation of effective remedial actions to prevent recurrence. Loss trend analysis can help to identify underlying systemic issues Better understanding of the firm’s risk profile will result in more effective risk control strategies

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Importance of Loss Management
• Assists in better management of operational risk More effective risk and control assessments Ability to benchmark firm’s loss profile against peers (subscribe to a loss data consortium) Sharing of lessons learnt from loss ‘case studies’ will heighten risk awareness More effective use of insurance for risk mitigation

Contributes towards a more robust operational environment that will improve the bottom line as well as better service quality 9

Importance of Loss Management
• For measurement of operational risk (i.e. capital modeling) statistical modeling of operational risk requires complete and accurate loss data Provides information for more realistic scenario analysis (together with external loss data)

Probability

Annual aggregate loss ($)

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Issues and Challenges • People may omit reporting losses for various reasons • Fear – Will I lose my job? Will I lose my bonus? • Lack of understanding - Is it an operational risk loss? Is it reportable? Is it my responsibility to report it?

• Difficult to detect if people intentionally hide losses • Losses may not be correctly categorised and not all loss elements may be reported e.g. legal expenses and other costs related to the event

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Critical Success Factors
• Board and senior management must set the ‘tone from the top” • Incentivize good risk management • Instill culture of openness and transparency -“Speak up” culture • Communicate risk appetite...
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