During the last twenty years operational risk has gained in importance in the financial sector. Although this type of risk is definitely not new but rather one of the oldest, it has remained unconsidered for a relatively long time. However operational risks have always existed and do exist in the daily business ever since the foundation of every financial institution.
Considering the increased complexity and global developments in the financial system as well as the recent extremely large losses caused by operational risk, this risk type has finally acquired a greater relevance. One of the most popular examples for the tremendous losses caused by operational risk is the collapse of the Barings Bank in the year 1995 due to an inadequate control system and serious failures in management and supervisory.
Unlike other types of risks operational risks are very heterogeneous and diversified. The term includes a variety of meanings and range from employee errors, systems’ failures and frauds up to external events, such as fire or floods. Therefore the former definition of operational risk was a negative one, which stated what the term is not – e.g. credit, market or liquidity risk – it was the “other risks” basket (Utz 2006: 52). But this definition has proven to be “opaque and less than useful” (Carol 2003: 104) and is now obsolete.
Since a consistent definition is absolutely necessary for a general framework for managing and controlling operational risks, the Basel Committee provided a more precise definition. It defines the operational risk as: “the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events” (BCBS 2001: 2). This definition includes also the legal risk, but not the reputation risk and strategic risk. A lot of industry representatives applied this definition, hence it can now be assumed as the standard one.
According to this definition, the operational risk can be divided into two main streams of risk: the external and the internal risk: The internal risk arises inside the institution, whereas the external risk arises outside the institution.
Table of Contents
1. Introduction and Definition
2. Important Regulatory Requirements of Operational Risk
2.1 The Basel Capital Accord
2.1.1 The First Pillar: Minimum Capital Requirements
2.1.2 The Second Pillar: Supervisory Review Process
2.1.3 The Third Pillar: Market Discipline
2.2 Sound Practices
2.3 The National Implementation of Basel II in Germany
3. The Operational Risk Management Process
3.1 Risk Identification
3.2 Risk Assessment
3.3 Reporting
3.4 Management of operational risks
3.4 Monitoring
Objectives and Topics
This paper aims to provide a comprehensive analysis of operational risk in the financial sector, focusing on the regulatory framework established by the Basel Committee and the practical implementation of risk management processes in banks.
- Definition and categorization of operational risk factors (people, systems, processes, external events).
- Regulatory requirements under Basel II, specifically the Three Pillars approach.
- Implementation of international banking standards within the German regulatory environment (MaRisk, KWG).
- Detailed examination of the operational risk management cycle, including identification, assessment, reporting, mitigation, and monitoring.
Excerpt from the Book
3.1 Risk Identification
The first stage of the process refers to the identification of operational risk. To identify the operational risk all the essential information about actual losses, near-losses, historical losses and risk potentials, should be collected. Furthermore critical processes and resources can be included (Wiley 2013: 16).
To record historical losses which are caused by operational risk it is advisable to implement an independent data base, that focuses exclusively on this type of loss, because mostly the existing data bases of the institution are not made for these purposes (Kaiser/Köhne 2007: 44 f.).
The determination of potential losses can only be conducted implicitly by an analysis of the infrastructure and the production processes of the institution (Khan 2013: 13.36). However, the determining of the near-losses is less complicated, because it is based on eliminated mistakes, which have been discovered during the production process by the internal control mechanism. These eliminated mistakes can be listed as near-losses. The problem about the risk identification on the basis of potential losses and near-losses is its significant degree of subjectivity (Kaiser/Köhne 2007: 46).
Another method of collecting information about operational risk losses occurs on the base of indicators. Therefore statements about the occurrence of losses can be made, because this method constructs a connection between one or more indicators and potential or passed losses. In this way information about operational risks can be derived from this connection. The advantage of indicators is their large objectivity, because they can be verified and determined simply, but the actual connection between the indicator and the occurrence of risk remains uncertain.
Summary of Chapters
1. Introduction and Definition: This chapter introduces the increasing importance of operational risk in the financial sector and provides the standard definition established by the Basel Committee.
2. Important Regulatory Requirements of Operational Risk: This section details the Basel II framework, specifically the three pillars of regulation, and discusses how these international standards are implemented in Germany.
3. The Operational Risk Management Process: This chapter examines the specific steps of the risk management cycle, covering identification, assessment, reporting, mitigation strategies, and monitoring.
Keywords
Operational Risk, Basel II, Banking Supervision, Risk Management, Capital Adequacy, Risk Identification, Risk Assessment, Internal Control, Financial Stability, Regulatory Requirements, Risk Mitigation, Monitoring, Reporting, Market Discipline, MaRisk.
Frequently Asked Questions
What is the primary focus of this paper?
The paper focuses on defining operational risk and exploring how financial institutions can manage this risk effectively within the regulatory constraints of the Basel II accord.
What are the main thematic areas covered?
The main themes include the classification of risk factors, the regulatory architecture of Basel II, German national implementation, and the procedural cycle of managing and controlling operational risks.
What is the core research goal?
The goal is to explain how banks identify, measure, and mitigate operational risks to ensure financial solvency and compliance with supervisory requirements.
Which methodology is applied in the research?
The research is based on a descriptive analysis of regulatory literature, international banking standards (BCBS documents), and academic management theories regarding risk processes.
What does the main body of the text cover?
The main body covers the Three Pillars of Basel II, the "Sound Practices" guidelines, and the practical five-step management process of risk identification, assessment, reporting, management, and monitoring.
Which keywords best characterize this work?
Operational Risk, Basel II, Risk Management, Capital Adequacy, and Banking Supervision are the most defining keywords.
How does the paper differentiate between internal and external risks?
Internal risks arise from people, systems, and processes within the institution, while external risks originate outside the institution, such as natural events or criminal acts.
What is the role of the "Advanced Measurement Approach"?
It allows institutions with sophisticated risk management systems to develop their own internal models for calculating required capital, provided they meet specific qualitative and quantitative criteria.
- Citation du texte
- Elvira Peters (Auteur), 2015, Operational Risk. The Regulatory Requirements and Management Process, Munich, GRIN Verlag, https://www.grin.com/document/324197
