THE EFFECTIVENESS OF OPERATIONAL RISK MANAGEMENT ON FINANCIAL INSTITUTION
Alan Greenspan, Chairman of the Federal Reserve American Bankers Association, during Annual Convention on October 5, 2004 held, “It would be a mistake to conclude that the only way to succeed in banking is through ever-greater size and diversity. Indeed, better risk management may be the only truly necessary element of success in banking.”
Banks and financial institutions are undergoing a sea change and today face an environment marked by growing consolidation, rising customer expectations, increasing regulatory requirements, proliferating financial engineering, uprising technological innovation and mounting competition. This has increased the probability of failure or mistakes from the operations point of view – resulting in increased focus on managing operational risks.
Operational risk losses have often led to the downfall of financial institutions, with more than 100 reported losses exceeding US0 million in the recent years. The regulators of financial companies and banks are demanding a far greater level of insight and awareness by directors about the risks they manage, and the effectiveness of the controls they have in place to reduce or mitigate these risks. Further, compliance regulations, like Basel II and SOX, mandate a focus on operational risks, forcing financial organizations to identify, measure, evaluate, control and manage this ubiquitous risk. This has led to an increased emphasis on the importance of having a sound operational risk management (ORM) practice in place, especially when dealing with internal capital assessment and allocation process. This makes ORM one of the most complex and fastest growing risk disciplines in financial institutions (http://www.metricstream.com/solution_briefs/ORM.htm).
Operational Risk: Changing Face of Compliance
Old perceptions and behaviors towards risk are changing. ORM is acquiring new credibility as a roadmap to add value to the business; and is garnering new attention from regulators and key stakeholders.
A recent Chartis Research’s1 report on ORM systems, suggests that the worldwide financial services ORM market will continue to grow, reaching a total value of .55 billion by 2011. This indicates a growing concern among banks and financial institutions for managing their operational risk. The report has three main findings:
Many US and European financial institutions continue to replace their first generation ORM systems – largely due to inflexible and rigid product design and the ongoing evolvement of ORM methodologies.
Some market segments, such as emerging regions (e.g. Middle-East, Asia-Pacific, South America), and vertical sectors (e.g. insurance, asset management) have begun investing in formal and sophisticated ORM systems.
Average investment in ORM projects is increasing, as more and more financial institutions are focusing on ORM’s strategic business benefits
Additionally, the report claims financial institutions working on the demand side of the market are reexamining their approach, culture and systems for managing operational risk.
Operational Risk in Financial Institutions
During the past decade financial institutions have been modifying both their products and internal processes at a rapid pace leading to an increased exposure to operational risk. Consequently supervisors of financial institutions have expressed increased concerns on institutions’ potential exposures to operational risk and institutions will be required to enhance their risk management capabilities with respect to their operational processes. Although well-defined tools and techniques are used for the assessment and modeling of financial risks inherent in financial products, comparable approaches are still in a developing stage on the operational risk side. Up to now, no international agreement has been reached on how to actually implement or assess compliance with those requirements. This research aims at showing that a solution for the assessment of operational risk management compliant with ISO/IEC 15504 standards may form a sound basis to meeting those future regulatory requirements.
Credit:ivythesis.typepad.com
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