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Operational risk is one of the most complex and broad risk faced by financial
institutions. Operation means processed systems which are used in the
organization. It is there in every nook and corner of the organization. It is not easy
to manage this risk.
Operational risk is faced by all types of organizations. No organization can avoid it.
Simpler organizations will face lower or simpler form of operational risk. A complex
organization will face greater or complex form of operational risk.
Operational risk always arises from deviations which come in business enterprise.
When organization deviates from planned path and actual performance does not
match with planned performance.
DEFINITION: it is a risk of loss resulting from inadequate or failed internal
process or people or system or any external event (like earthquake). This all
results in operational risk.
It affects the profitability position of the company. Operational risk can result in
lower business volume.
HOW IT EMERGED?
Operational risk was always there in the banking system. It has no doubt become
important suddenly because earlier selected financial products were offered,
interest rates were regulated etc.
But now technological advancements, geographical outreach, deregulated regimes,
plethora of financial services offered, complexity of products, complexity in
organization structure is there, so operational risk has become more prominent.
1.
2.
3.
4.
Cause
based
classificatio
n
People
oriented
causes
Process
oriented
causes
Transaction
Based
Effect based
classificatio
n
Technology
oriented
causes
Event based
classificatio
n
External
causes
External
control
based
Process
oriented
causes
Transaction
Based
Operationa
l control
based
Any regulation compliance not done like tax evaded, not filed
documents with RBI will result in operational risk
Loss or damage to assets
o
o
STEP II - QUANTIFYING
OPERATIONAL RISK
OR
MEASURING
THE
It is the most difficult task to measure the operational risk. Behaviour pattern
of operational risk does not follow the statistically normal distribution pattern
and that makes it difficult to estimate the probability of an event resulting in
losses. There are three approaches to measure operational risk:
i.
The basic indicator approach
ii.
The standardized approach
iii.
Advanced measurement approach
Of these, basic indicator approach and standardized approach are based on income
generated. The advance measurement approach is based on operational loss
measurement.
i.
must hold capital for operational risk equal to average over the previous
three years of a fixed percentage (15%)of positive annual gross income.
Figures for any year in which annual gross income is negative or zero should
be excluded from both the numerator and denominator while calculating the
average.
Capital Charge = Average Gross income of previous 3 years * 15%
ii.
activities are divided into 8 business lines: Corporate finance, trading and
sales, retail banking, commercial banking, payment and settlement, agency
services, asset management and retail brokerage.
Within each business line, gross income is a broad indicator that indicates the likely
scale of operational risk exposure within each of these business lines. The capital
charge for each business line is calculated by multiplying gross income by a factor
(Beta) assigned to that business line.
Business lines Beta Factors
iii.
high
level
of
STEP IV REPORTING
The top management has to make a report relating to the level of operating
risk prevailing in the organization. This report has to be submitted to RBI on
fortnightly basis.