The importance of operational risk in banking and how it is allowed for the Basel capital accords

Thèmes abordés

Operational risk, banking, Basel capital accords, credti risks, market risks, operational risks

Résumé du document

Risks in banking sector are related to a number of unpredictable events that one cannot forecast which could cause huge consequences on the activity of a bank. Hence, its ability and its expertise in managing those risks is a major challenge for the sector and its sustainability.
Here are the major risks that the banks are confronting: Credit risks, Market risks and Operational risks.
In the recent events, such as the Subprime mortgage crisis and Societe Generale fraud case has proven the weakness of the number of processes of risks containment within the banks and the financial sector. Such events have strengthened the necessity and the need establishing an operational process control within the financial institutions.

Extraits

[...] The importance of operational risk in banking and how it is allowed for the Basel capital accounts Risks in banking sector are related to a number of unpredictable events that one cannot forecast which could cause huge consequences on the activity of a bank. Hence, its ability and its expertise in managing those risks is a major challenge for the sector and its sustainability. Here are the major risks that the banks are confronting: Credit risks, Market risks and Operational risks. [...]

[...] The use of this method requires prior approval by the supervisor. The model should be used: - Internal data (history of 5 Years - 3 years at the time of implementation) or external data adjusted to make them internally compatible. - Analysis by scenario with an assessment of the risk of intensity (Low probability high impact). - Environmental assessments and internal control system. These three approaches are designed to quantify operational risk with different sensitivity to contribute to a better monitoring of this risk. [...]

[...] This is particularly the case for exceptional risks such as natural disasters, which have a very low probability of occurrence but potentially very severe In addition to these measurement tools, the Basel Committee has developed necessary principles for a good management of operational risks. Also has enforced using a standard approach, with an advanced detailed measurement to respect specific criteria in the corporate governance, audits and also in the internal control. A bank must have an operational risk management function properly identified, responsible for the establishment and implementation of those measurements and the management of this risk. This concept must be integrated into the daily risk management of the institution; the risk must be adequately monitored and reported. [...]

[...] In order to qualify for use of the standardized approach, a bank must satisfy its regulator that, at a minimum - taking into account the quality of the system put in place to manage the risk and regularity in the follow up and the control of the capital losses. Advanced Measurement Approaches Where the risk is measured by internal process within the institution. Multiple approaches can be adopted: Internal Measurement Approach, Approaches based on the modeling of loss (or LDA: Loss Distribution Approach) and approaches based on a scoring business lines (Scorecard Approach). [...]

[...] Operational risks are sourced from all of the banking professions, such as intermediation activities, market activities or services on behalf of third party. Which resulted into a study of the operational risks taking into account internal and external factors to the bank: e.g. Risks of procedures: caused by human or systems failures, fire, network and system failures, legal and tax risk, Internet risk and risks of money laundering and fraud. Based on this definition, Basel ll accord has setup risk and capital management requirement designated to ensure that bank has adequate capital for its exposed risks. [...]