Unit-2

Operation Risk Management

&
Non Performing Assets

References:
Iyengar V. (2007), Introduction to Banking, 1st Edition, Excel Books,
New Delhi.
Sethi Jyotsna & Bhatia Nishwan (2012), Elements of Banking &
Insurance, 2nd Edition, PHI, New Delhi
 Operational Risk Management
• Guidelines for Risk Management System in India RBI
– Organizational Structure
– Comprehensive Risk Management Approach
– Risk Management policy – strategies, capital strength,
management expertise and overall willingness to assume risk
– Guidelines and other parameters – govern risk – detailed structure
of prudential limits
– Strong MIS- reporting, monitoring and controlling risk
– Well laid out procedures, effective control and comprehensive
risk reporting framework
– Separate risk management- independent of operational
department and clear – level of responsibility for mgt. of risk
– Periodical review and evaluation

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 Definition of Operational Risk
• ‘The risk of loss resulting from inadequate or
failed internal processes, people and systems or
from external events.’
• It includes legal risk, not strategic and reputation
risk
• Legal risk includes –fines, penalties, punitive
damages resulting from supervisory actions, as
well as private settlements.

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 Objective of ORM
• To minimize operational risk and strengthen internal control- appropriate
policy, procedure, strategy, framework and risk cultural
• Objectives:
– Identify operational loss events and analyze their causative factors
– Build up robust database for operational loss
– Estimate expected and unexpected losses; allocate capital for
operational risk
– Set up prudential limits
– Mitigate and control the factors leading to expected losses
– Protect against unexpected losses
– Make audit mechanism independent of operation

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 Benefits of ORM
• It is a sound practices for the Management and
Supervision of OR - bank will be able to
– Identify the internal and external causative factors to lead
– Understand the risk drivers
– Strengthen internal controls to minimize operational risk
– Find out the extent of bank’s OR exposure
– Allocate capital for operational risk
• ORM process provide ‘warning signals’ that assist
management in making better informed decisions

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 Risk Terminology
• Risk: the uncertainty that surrounds future events
and outcomes. It is the expression of the likelihood
and impact of an event with the potential to influence
the achievement of corporate objectives.
• Operational Risk Management: Continuous
systematic process of identifying and controlling
operational risk– set pre determine parameter’s by
applying appropriate policy and procedures
It includes detecting hazards, assessing risks,
implementing and monitoring risk control to support
better decision making
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 Risk Terminology
• Risk Event (Hazard): incident or set of it that results
into actual /potential or direct/indirect or a near-miss
loss.
• Loss Events: OR incidents that result in a loss to the
bank.
• Actual / Direct Loss: that impact on P & L a/c of bank
• Potential Loss: that could take place on account of loss
event
• Cause of an Event: is the action or set of circumstances
• Probability of Event: the likelihood of occurrence of an
event

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 Risk Terminology
• Indirect Loss: Loss arising out of unexpected increase in
expenditure in order to solve operational problem and
increasing opportunity cost owing to material events and
reputation risk.
• Reputational Risk: do not have potential to culminate in
direct loss but indirect loss of enormous magnitude by
damage to the reputation of the bank
• Near Miss Events: Which could have resulted in a loss,
had it not been discovered and corrected in time.
• Effect of an Event: loss of monetary or non-monetary

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 Types of Operational Risk
Business
People Risk Process Risk Governance risk Environment Risk IT Risk
Operational Risk

Business Processes Customer

Human Resource Leadership Risk Regulatory Risk Technology Risk
Risk Satisfaction
Resource Customer Relation
New Product Risk Communication Risk Event Risk Access Risk
Allocation Risk
Risk Relating to Product Quality Disaster Prevention
Outsourcing Risk Media Risk Data Validity Risk
Wrongful Act Risk and Recovery Risk
Product Product
Record Keeping Budget Planning Economic Data Integrity
Development Obsolescence
Business Data Availability &
Employee Error Internal Control Poor Marketing
Interruption Connectivity

Work Place Safety Systems and Data Transmission

Competition
And Environment Control Risk

Compliance Risk Inability to Change IT Infrastructure

Business
Manager IT Application
Concentration
Building and
Poor MIS
Equipment
Relationship Risk

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 People Risk
• Human Resource:
– lack of adequate skills, knowledge and experience
• Resource Allocation
– poor allocation of resource
• Risk Relating to Wrongful Act- committed by
employees
• Record Keeping
• Employee Error-
– Poor performance – to incorrect / error in transactions
• Work Place Safety and Working Environment
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 Process Risk
• Business Processes Risk
• New Product Risk
• Product Quality Risk
• Product Development
• Business Interruption
• Systems and Control
• Compliance Risk
• Merger

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 Governance Risk
• Leadership Risk
• Communication Risk
• Disaster Prevention and Recovery Risk
• Budget Planning
• Internal Control

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 Business Operation Risk
• Customer Satisfaction
• Customer Relation Risk
• Outsourcing Risk
• Product Obsolescence
• Poor Marketing
• Competition
• Inability to Change
• Business Concentration
• Poor MIS
• Relationship Risk
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 Environment Risk
• Regulatory Risk
• Event Risk
• Media Risk
• Economic

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 IT Risk
• Technology Risk
• Access Risk
• Data Validity Risk
• Data Integrity
• Data Availability & Connectivity
• Data Transmission Risk
• It Infrastructure
• It Application
• Building and Equipment
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 Operational Risk Management Process

Monitoring and
control
Assessment

Identification

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 Risk Identification
• Identify and assess – product, activities, process
and system on continuous basis through Risk and
Control Self Assessment approach
• Different Levels
– Level 1: list main business group- corporate finance,
trading and sales, retail banking, commercial banking,
agency service, asset management, etc.
– Level 2: list out the product teams- transaction, trade
finance, cash management, security market, general, etc.
– Level 3: list out the product offered – import bills, letter
of credit, bank guarantee, trade finance, etc.

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 Risk Identification
• Risk event are associated with the people, process
and technology involved with the product:
– Experience- he event occurred in the past
– Judgment- Business logic suggestions that it is a risk
– Intuition – event where appropriate measures saved
the institution in the nick of time.
– Linked Event- This event resulted in a loss resulting
from other risk type
– Regulatory environment

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 Risk Assessment
• Risk & Control Self-Assessment
• Process Mapping
• Key Risk Indicators

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 Risk & Control Self-Assessment
• Operational risk experts to identify and assess
risks in order to plan appropriate actions

• Objectives
– Identification
– Assessment
– Monitoring
– Mitigation / Control

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 Risk & Control Self-Assessment
• Self Assessment Process
– Generic Process- all activities/ product undertaken
– Mapping- nature and preparation of generic steps
– Conduct of workshop of risk experts to sensitize them
– Identification of key risk areas & OR loss events
– Identification of Operational Risk – with brief
description
– Assessment of potential events with causative factors
– Documentation of entire exercise – different steps, key
findings, action taken
– Repetition of the exercise for all business lines.
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 Risk Mapping Process
• It is a technique, which will enable the banks to
identify, describe, understand and ultimately
improve the processes, which take place within
an organization of any of its divisions
– A technique to identify and understand how process
operate
– A tool to manager, monitor and improve processes
– An effective means of training employees

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 Risk Mapping Process
• Bank’s Generic Product Process Mapping
Origi Custom
er Oper Monit Misc.
natio Acquisi
n tion
ation oring Issues
Customer
● Exception
●
●
Product Designing
●
●
●

interface
●
●Initiation &
reporting
HRD Issues
●
●
Product
●
●

Updating in the
Development Information
●
● Continuous
●
● Technology
●
●

system
Product Testing
●
exchange verification Issues
●
●
●Client Servicing
Product Approval
●
Verification and Recourse
● ●
● ●
●
●
●Product feedback Audit Issues
●
●
Product Roll out
●
●
approval MIS
●
●

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 Risk Mapping Process
• Key Risk Indicators
– Number of failed trade
– Staff turnover rate
– Network outrage time
– Frequency and severity of errors and omissions, etc

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 NON-PERFORMING ASSETS (NPA)
• NPA’s are those categories of assets (advances,
bill discounted, overdraft, cash credits) which
cease to generate income for the bank.
• The basis for treating a credit facility as non-
performing is as follows:
I. Where the interest on instalments on a term loan
remains overdue for a period of more than 90
days.
II. Any bill which remains overdue for a period of
90 days.
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III. Any Amount due on any other loan which
remains overdue for a period of 90 days.
IV. Any cash credit/overdraft which remains out of
order for a period of 90 days.

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 ASSET CLASSIFICATION.
• Bank in India are required to categorize NPAs on
the basis of
A. The period for which the asset has remained
non-performing .
B. The realizability of the dues.
The committee suggested a classification of assets
into the following:
 Standard.
 Sub-Standard.

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 Doubtful.
 Loss asset.

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 Thank You

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