CAIIB BFM Unit 14 - Operational Risk

Operational Risk is the risk of loss resulting from
• Inadequate or failed internal processes, people and system.
• External events such as dacoity, burglary, fire etc.
It includes legal risks but excludes strategic /reputation risks.

Identification
• Actual Loss Data Base
• RBIA reports
• Risk Control & Self Assessment Survey
• Key Risk indicators
• Scenario analysis

Four ways to manage Risk
• Prevent
• Reduce
• Transfer
• Carry/Accept

Operational Risk – Measurement
Three approaches have been defined to measure Operational Risk at the bank:

1. Basic Indicator approach
2. Standardized approach
3. AMA i.e. Advanced measurement approach

Basic Indicator Approach
15% of Average positive gross annual income of previous 3 years will be requirement of capital.
To start with banks will have to adopt this approach and huge capital is required to be maintained. In our bank, estimated requirement of capital will be about Rs. 1000 crore.

The Standardized Approach
All banking activities are to be divided in 8 business lines. 1) Corporate finance 2) Trading & Sales 3) Retail Banking 4) Commercial Banking 5) Asset Management 6) Retail brokerage 7) Agency service 8) Payment settlement
Within each business line, Capital requirement will be calculated as under:

By multiplying the average gross income generated by a business over previous 3 years by a factor β ranging from 12 % to 18 % depending upon industry-wise relationships as under:
Retail Banking, Retail Brokerage and Asset Management-----------12%
Commercial Banking and Agency Services---------------------------15%
Corporate, Trading and Payment Settlement------------------------18%

Advanced Measurement Approach
Capital requirement is calculated by the actual risk measurement system devised by bank’s own internal Operational Risk Measurement methods using quantitative and qualitative criteria. Our bank has started measuring actual losses and estimating future losses by introducing statement of Operational Risk Loss data w.e.f. 1.4.2005. Minimum 5 year data is required for a bank to switch over to AMA.