Basel 2 Norms on Operational Risk

Agenda
 Risk- General  Operational Risk  Introduction to Basel 2  Operational risk and Basel 2  Approaches to Operational Risk  Managing Operational Risk  Who should manage operational risk

Risk - General
 There is no risk free activity  Only degrees of risk - high to low  Nothing risked nothing gained  High risks bring in high gains  Risks if not managed well can result in disaster  Banking business is one of taking risks

Operational Risk (OR)
 OR is all about people, processes and systems that are present in financial institutions intrinsically.  Once recognized mitigation through insurance possible.  The OR is fuzzy  Credit Risk identified as Default Risk but is a Business Risk. But Manager violating norms of sanctioning borders on OR.

Operational Risk
Types of OR
Internal Fraud
External Fraud Employment Practices & Workplace Safety Clients, Products & Business Practices Damage to Physical Assets

Examples
 Unauthorized transaction resulting in monetary loss  Embezzlement of funds  Branch robbery  Hacking damage (systems security)  Employee discrimination issues  Inadequate employee health or safety rules  Money laundering  Lender liability from disclosure violations or aggressive sales  Natural disasters, e.g. earthquakes  Terrorist activities  Utility outage (e.g. blackout)

Business Disruption and System Failures

 Data entry error Execution, Delivery & Process  Incomplete or missing legal documents Management  Disputes with vendors/outsourcing

Introduction to Basel 2
 Basel 2 is a type of recommendations on banking laws and regulations issued by the basel committee on banking supervision that was initially published in june 2004  Objective of basel 2 is to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face

Operational Risk and Basel 2
 The Basel Committee recognizes and defines operational risk in Basel II as “The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.”  The definition includes legal risk but excludes strategic risk (Risk of loss arising from a poor strategic business decission)and reputation risk.  Basel 2 is the international capital adequacy framework for banks that prescribes capital requirements for credit risk, market risk and operational risk.  Focused on causes/events that trigger Operational Risk and capable of measurement.

Approaches to Operational Risk
 Basic Indicator approach Based on annual revenue of the financial institution  Standardised approach Based on annual revenue of each of the broad business lines of financial institution  advanced measurement approach Based on the internally developed risk measurement framework of the bank adhering to the standards prescribed

Managing Operational Risks
 Avoiding the unexpected losses and creating a “No Surprise culture” through judicious risk management practices. Challenges:  Mergers and Acquisitions  Alliances; Associates; Subsidiaries

 Changing customer expectations

Who should manage OR
 Board: responsible for the high level policies  Top management: responsible for creating a structured control environment and laying down procedures  Middle management: implement the Risk practices conforming to the above.  Statutory Auditors: Ascertain if the Internal controls are adequate enough to mitigate the risks.

Thank You
Presented By:
Debasish Devkumar padhy

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