Operational Risk

Overview

Operational Risk

As per Basel, Operational Risk is the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events. Some of the types of operational risk are internal and external fraud, damage to physical assets, business disruption and system failures, execution, and process management etc.

Operational Risk is a coin with two sides as Operational Risk Measurement and Operational Risk Management. Operational Risk Measurement is basically concerned with the capital calculation based upon the various methods as per Basel. Effectively managing operational risk is somewhat a qualitative task which comes under operational risk management. The blend of this quantitative and qualitative approaches is what constitutes as successful Operational Risk program.

Operational Risk is a coin with two sides as Operational Risk Measurement and Operational Risk Management. Operational Risk Measurement is basically concerned with the capital calculation based upon the various methods as per Basel. Effectively managing operational risk is somewhat a qualitative task which comes under operational risk management. The blend of this quantitative and qualitative approaches is what constitutes as successful Operational Risk program.

Offerings

Our Offerings towards Operational Risk

Operational Risk Framework

Risk Control Self-Assessment (RCSA)

One of the major steps in the operational risk program is Risk Control & Self-Assessment (RCSA), wherein the business units within the organization identify and evaluate the risks incurred, their specific level of control over these risks and action points for improvement. The starting point for self-assessment is a comprehensive set of risk definitions, usually a set of major categories and detailed sub-categories. The next step is, identification and assessment of the risks, typically takes the form of a risk heat map that shows risks by business area and their relative frequency and severity.

One of the major steps in the operational risk program is Risk Control & Self-Assessment (RCSA), wherein the business units within the organization identify and evaluate the risks incurred, their specific level of control over these risks and action points for improvement. The starting point for self-assessment is a comprehensive set of risk definitions, usually a set of major categories and detailed sub-categories.

The next step is, identification and assessment of the risks, typically takes the form of a risk heat map that shows risks by business area and their relative frequency and severity.

Key Risk Indicator (KRI)

After RCSA Key Risk Indicator (KRI) framework is established, wherein key operational risks are identified in the identified risk entities of the organization. There are different types of KRI, such as:

  • KRIs to be identified with the operational risk management group
  • KRIs which are process specific indicators
  • Threshold levels for the identified KRIs are established in conjunction with the monitoring, reporting and escalation processes

After RCSA Key Risk Indicator (KRI) framework is established, wherein key operational risks are identified in the identified risk entities of the organization. There are different types of KRI, such as:

  • KRIs to be identified with the operational risk management group
  • KRIs which are process specific indicators
  • Threshold levels for the identified KRIs are established in conjunction with the monitoring, reporting and escalation processes

Loss Data Management

To measure operational risk Loss data is required. Loss data being scarce in operational risk, firms generally pool their data so that it can be used by all of them for measurement purposes. Specifying what constitutes the loss and defining various components required for capturing loss data such as risk category level, cash recovery, loss type, business line etc. is one of the most important steps while compiling loss data. This can be done by creating a loss data template which captures the details of all loss events in an organization including near misses.

We support our clients to establish ‘Operational Risk Data Mart’ to collect the loss data in systematic way. We have developed our own set of meta data that needs to be captured for modelling operational risk capital in line with Advanced Measurement Approach as stipulated by Basel.

We support our clients to establish ‘Operational Risk Data Mart’ to collect the loss data in systematic way. We have developed our own set of meta data that needs to be captured for modelling operational risk capital in line with Advanced Measurement Approach as stipulated by Basel.

Advanced Measurement Approach

The Basel II framework requires banks to hold capital charge for operational risk under Pillar I. It prescribes three methods for calculating operational risk capital charges in a continuum of increasing sophistication and risk sensitivity. Banks are recommended to move along the spectrum of all the available approaches as they develop more sophisticated operational risk measurement systems.

The Advanced Measurement Approach (AMA) is the most sophisticated approach.

This approach does not use Gross Income, but loss data to model the losses. The Loss Distribution Approach (LDA) is one of the most accepted methods currently available within the AMA. Under the LDA approach, we help our clients to assess the frequency and severity distributions of operational risk losses of operational risk event class are estimated. These distributions are used to model the aggregated loss distribution by using Monte Carlo simulation.

Key benefits of adoption of AMA

  • Expected to reduce capital charge for operational risk as compared to Basic Indicator or Standardized Approach.
  • It will enable the bank to measure and manage the operational risk in more advanced manner.
  • Computation of capital under AMA would indicate a more realistic operational risk profile of the bank, which would help it in improving capital budgeting and internal capital management exercise.

To calculate the operational risk, operational risk VaR methodology, in line with Advanced Measurement Approach (AMA) of Basel II is developed. Some of the methodologies that can be used are:

  • Loss Distribution approach
  • Scenario Analysis Approach
  • Hybrid Approach
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