Introduction

The Basle Committee on Banking Supervision last year initiated work related to operational risk, explaining that “Managing such risk is becoming an important feature of sound risk management practice in modern financial markets”.  In a time when external market pressures lead to high potential exposure through market and credit risk, operational risk is quite often overlooked. This is mainly due to the lack of measurement of risk and the lack of systems to control this risk.

The three main risk areas that are regularly identified within a Financial operation are Credit Risk, Market Risk and Operational Risk. There are many others which may arguably fit into these general categories, but the principle behind highlighting these is that of these risk areas, the only one which the Bank or Financial organisation has any control over is Operational Risk. The others are driven by market pressures, exchange rates, commodity prices, economy growth or inflation etc. 

Operational Risk Defined

Many banks define operational risk as that risk not categorised as market or credit risk, whilst others define it as the risk of loss arising from various types of human or technical error. The majority of respondent banks associate operational risk with settlement or payments risk. In truth, they are probably all right as Operational problems could well lead to market or credit risk as with settlement fails.

There are many factors which directly contribute to and signify problems with Operational Risk.

• Human error is the most common contributing factor and whilst it is certainly possible to monitor and control this, it is far better to have a system which regulates itself, i.e. eliminate human error as much as possible.

• Poor systems design and implementation can be cited in a lot of occasions where an institution has decided to develop in-house as a “stop-gap” measure which has then become the norm. 

• Loss experience is more an alarm bell than a contributing factor, but if noticed early enough can be both.

• Income volatility, like loss experience can be both although in particular areas income volatility will certainly signify that there is a level of operational risk not being monitored.

• Increased exception handling will almost definitely signify an operational risk problem as either human error is increasing or the systems in place cannot cope for whatever reason and this will almost always lead to exposure through late settlements of one form or another.

• The final area to highlight is Settlement Fails, Payment Control errors etc. and these, like exceptions increasing, signify a radical operational problem and high risk as they onward impact credit and market risk and have a knock on effect. Control of these will have a significant effect on other areas of risk management as well as the bottom line profitability of a bank.

Control and Management through Technology

Proven, effective technology can be used to both control and manage operational risk especially in the areas of highest potential exposure - Settlements, Cash Position keeping, Advices etc.  In the first instance a computerised system can handle a lot more than a human being and a lot more efficiently. This gives increased productivity and potential increased profitability.  Irrespective of the experience of the Settlements or Reconciliations clerk, the computer system will return the same consistent level of quality in dealing with transactions. It can also handle virtually unlimited growth.

Obviously a ”smart” system will reduce settlement errors and thus reduce the potential exposure in credit and market risk areas. Due to the increased speed in processing, identifying and managing exceptions there will be a reduction or at least a complete control of Bank Compensation payments for late settlements.  With efficient reconciliations and Confirmations Matching, a bank should have a much better control on the cash position and thus possibly take further advantage of both inter and intra day deposits.

It is important to understand that whilst automation can improve the bottom line, standards must also be maintained and thus any system must be well proven with a security of design for the future, year 2000 compliant, Euro enabled and use the most up-to-date technologies.

For information, contact:

Euro Banking Solutions
email:information@eurobankingsolutions.com