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Member Education Series Seminar Indian Institute of Banking & Finance Nagpur November 2005
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Agenda
Definition Causes/Contributors Process Gross Income Computation of Capital Charge Approaches Assessing events Measurement basis Monitoring Data requirements Management tasks
Definitions
Operational risk (OpRisk)has been defined by the Basel Committee on Banking Supervision as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. Management of Operational Risk means and includes identification, assessment, monitoring and control/mitigation of this risk.
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Causes of OpRisk
Internal fraud External fraud Employment practices and workplace safety Clients, products and business practices. Damage to physical assets. Business disruption and system failures Execution, delivery and process management
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Causes of OpRisk
Highly Automated Technology Emergence of E- Commerce Emergence of banks acting as very large volume service providers Outsourcing Large-scale acquisitions, mergers, demergers and consolidations Engagement in risk mitigation techniques giving rise to legal risk
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Contributors to OpRisk
People Risk Process Risk Transaction Risk Documentation/contract risk. Operational Control Risk Model Risk Systems Risk Technology Risk MIS Risk. Legal and Regulatory Risk Event Risk
Appropriate policies and procedures Efforts to identify and measure operational risk Effective monitoring and reporting A sound system of internal controls, and Appropriate testing and verification of the Operational Risk Framework
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The Basel Committee has allowed each relevant national supervisor to define gross income. RBI defines gross income as follows,
Gross income = Net profit (+) Provisions & Contingencies (+) operating expenses (Schedule 16) (-) profit on sale of HTM investments (-)income from insurance (-) extraordinary / irregular item of income (+) loss on sale of HTM investments
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OpRisk Approaches
Approach Basic Indicator Standardized Advanced Measurement Capital charge equals internally generated measures based on, Internal loss data External loss data Scenario analysis Business environment and internal control factors Recognition of risk mitigation (upto 20%) Calculation of Capital charge Average of Gross Income for three years as indicator Capital charge equals 15% of the indicator Gross income per regulatory line as indicator Depending on business line 12, 15 or 18 % of the indictor as capital charge Total capital charge equals sum of charge per business line
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Approach
Basic Indicator
OpRisk Approaches
Standardized Active involvement of Board of directors and Senior management Existence of OpRisk Management function Sound OpRisk Management system Systematic tracking of loss data
Advanced Measurement Same as standardized plus Measurement integrated into day-to-day risk management Review of management and measurement processes by internal/extern al auditor Numerous quantitative standardsin particular 3-5 years of historic data
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Qualifying criteria
No specific criteria Compliance with the Basel Committees Sound Practices for the Management and Supervision of Operational Risk recommended
Corporate finance Gross income b1 Trading and sales Gross income b2 Retail banking Gross income b3 Commercial banking Gross income b4 Payment and settlement Gross income b5 Agency services Gross income b6 Asset management Gross income b7 Retail brokerage Gross income b8
18 18 12 15 18 15 12 12
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Management tasks
Decision whether control for risk minimization or bear Risk mitigation tools as complementary to control Investment in technology and Information security Outsourcing policy-- development and adoption Impact of operational break downs and loss--intra and outside bank Business Continuity plans and testing Review of Business Continuity plans
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Organisational Set-up
Board of Directors Risk Management Committee of the Board Operational Risk Management Committee Operational Risk Management Department Operational Risk Managers Support Group for operational risk management
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THANK YOU
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