“Often the difference between a

successful person and a failure

is not one has better abilities or
ideas, but the courage that one
has to bet on one's ideas, to take
a calculated risk - and to act.”
By Andre Malraux

1
 What is Risk?
• Risk concerns the expected value of one
or more results of one or more future
events. Technically, the value of those
results may be positive or negative.
However, general usage tends focus only
on potential harm that may arise from a
future event, which may accrue either from
incurring a cost ("downside risk") or by
failing to attain some benefit ("upside risk
").
2
Basel Capital Accords - History

Accord Proposed Effective Focus

Basel I 1986 1988 Credit Risk

Basel 1.5 1996 1997 Credit Risk and Market

Risk

Basel II 1999 2007 Credit Risk, Market Risk

and Operational Risk

3
 Definition…Ops Risk

• Operations Risk ???

or
Operational Risk ???

• Operational risk is defined as “the risk of loss

resulting from inadequate or failed internal
process, people and systems or from external
events.” (BCBS, 644)

4
 DEFINITION OF OPERATIONAL RISK

Causal Categories:
Employee Behaviour
Potential or Corporate Behaviour
Forward looking Information Technology
External Environment
Force Majeure
any inadequate or failed
The risk of loss resulting from

from external events

internal processes

Inadequate collateral
External Fraud, management
Fire, Flood, Failed matching of cash &
Legal action, securities
“People and systems” in the Missed option exercise date
regulatory definition are Tax, Regulations,
False money, Unenforceable documentation
captured in internal process Internal fraud 5
Terrorism
 Dimensions of risk..!
Market Risk Credit Risk Operational Risk
Elements Securities Loans Processes

Level of Observation Trading Desk-Treasury Loan Portfolio- Through out the

and Market risk Credit Department Bank- Business Area

Mitigation Derivatives as hedging Credit Risk Insurance as risk

mechanism mitigants mitigant

Quantifiable Yes Yes Difficult

exposure

6
 RBI on Ops Risk

• Operational risk loss would be the financial impact associated with the
operational event that is recorded in the financial statement and would
include for example, (a) loss incurred, and (b) expenditure incurred to
resume normal functioning, but would not include opportunity costs
and foregone revenue etc.

• The banks must also track the potential loss (i.e. extent to which further
loss may be incurred due to the same operational risk event), near
misses, attempted frauds, etc
- where no loss has actually been incurred by the bank,
- from the point of view of strengthening the internal systems and controls
and
- avoiding the possibility of such events turning into actual operational risk
losses in future.
7
 Cont……
It includes legal risk, but excludes strategic and reputation risk.

Legal Risk includes, but not limited to, the risk of loss resulting
from failure to comply with laws, prudent ethical standards and
contractual obligation. It also includes the exposure to
litigation from all aspects of an institution's activities.

Linkage used as a common language for analyzing operational

risk by efficiently identifying, assessing and reporting
operational risk related information
Causes- Events- Effects

8
 Linkage..
Cause (Why did event happen?)
People
System
Process
External Events

Events (What Happened?)

Accounting errors, Inadequate record-keeping, Data entry errors, Employee illness
and injury, Insufficient employee capacities, Hardware/software failure,
Unavailability of data, Unauthorized access to information, Telecommunication
problems, Computer hacking or viruses, Fire/ natural disaster

Effects (What are the consequences?)

Legal Liability, Loss to assets, Regulatory Compliance, Reputation,
Business/Strategic Impacts
9
 Approaches in Operational Risk
Basic Indicator Approach

Crude -
generates

Incentives & Obligations

higher capital
charges
Standardised Approach
Subject to

qualitative

entry
criteria
Advanced Measurement

Sophisticated -
generates

lower capital charges

(and enhanced image!)
10
 Requirement of Capital for
Operational Risk
Basic Indicator Approach
15% of Gross Income of the Bank (on the basis of
average of gross income of the last three years)

The Standardised Approach

12% to 18% of Gross Income of the Bank (on the
basis of average of gross income of the last three
years)
Corporate finance (18%) Payment and settlement (18%)

Trading and sales (18%) Agency services (15%)

Retail banking (12%) Asset management (12%)

Commercial banking (15%) Retail brokerage (12%)

11
 Cont….
• Banks using BIA must hold capital for operational risk
equal to the average over the previous three years of a
fixed percentage (alpha) of positive annual gross
income.

Gross Income is defined as net interest income plus net non-interest

income. It should be:
- Be gross of any provisions;
- Be gross of operating expenses, including fees paid to
outsourcing service providers;
- Exclude realized profits/losses from the sale of securities in the
banking book; and
- Exclude extraordinary or irregular items as well as income 12
derived from insurance.
 Cont……
• The year in which annual gross income is negative or
zero should be excluded from both the numerator and
denominator when calculating the average. The capital
charge may be expressed as:
KB IA = [ ∑ (G I
1...n ]
*α ) / n
• KBIA = the capital charge under the Basic Indicator Approach
- GI = annual gross income, where positive over the previous three
years
- N = number of previous three years for which gross income is
positive
- α = 15 %, which is set by the committee, relating the industry
wide level of required capital to the industry wide level of the 13
indicator
 The Standardised Approach
• The total capital charge is expressed as:

KTSA = {
∑ ∑
year1 − 3
• KTSA = the capital charge under the Standardized
[
max
Approach
]
(GI1 − 8 * β 1 − 8),0 } / 3

• GI1-8 = annual gross income in a given year for each of the eight
business lines
• Β1-8 = a fixed percentage, set by committee, relating the level of
required capital to the level of the gross income for each of the eight
business lines. The values of the betas are:
Business Lines Beta Factors (%)
Corporate Finance 18
Trading and Sales 18
Retail Banking 12
Commercial Banking 15
Payment and settlement 18
Agency Services 15
Assets Management 12
Retail Brokerage 12 14
 Cont……
• The total capital charge is calculated as the three-year
average of the simple summation of the regulatory
capital charges across each of the business lines in each
year.
• In any given year, negative capital charge in any
business line may offset positive capital charge in other
business lines without limit.
• Where, the aggregate capital charge across all business
lines within a given year is negative, then the input to
the numerator for that year will be zero.

15
Identifying the appropriate unit of measure

16
 Advanced Measurement Approach

Capital Based on Internal Model.

• Loss Distribution Approach
(Frequency & Severity)
• Scenarios
• External Data
• Key Risk Indicators
• Risk Control Self Assessment (RCSA)

17
 Placing loss data in BL/ET cells helps
reveal the risk profile of each business

18
Using loss data to create Op Value at Risk

19
 RISKS SELECTION

PAYMENT
Fraud based on a fake paper based payment instruction with an internal collusion
Payment sent twice (payment validated into Payment system but not arrived in NY)
Fund frozen in NY for a payment in USD to a non authorised country (wrong
decision taken to by pass the Payment system control)
LOAN
Fraud on disbursement
Treasury announce missing position in NY affected and we lose interests due to
input error
TRADE
Late payment: payment should have been collected one week before (related to a
12 days delay due to the currency)
Discrepancies not detected for an L/C
TELLER
Check payment despite stop payment 20
 Key Risk Indicators

• In addition to monitoring operational loss events, banks

should identify appropriate indicators that provide early
warning of an increased risk of future losses.
• Such indicators (often referred to as key risk indicators or
early warning indicators) should be forward-looking and
could reflect potential sources of operational risk such as
rapid growth, the introduction of new products, employee
turnover, transaction breaks, system downtime, and so on.
• When thresholds are directly linked to these indicators an
effective monitoring process can help identify key material
risks in a transparent manner and enable the bank to act
upon these risks appropriately

21
 Cont..

• Centralized databases for the following for

providing data to KRIs and strengthening ORM
 Complaints
 Legal cases
 Frauds
 Attempted frauds
 System downtime
 Irregularities (including Audit)
• KRIs would be defined bank wide, but can be
monitored zone wise, region wise, bank wise,
etc.
22
 Risk Control Self Assessment.

• Risk assessment is the process of identifying and assessing risk

within a business unit
• Control assessment evaluates the effectiveness of controls that
are in place to manage these risks

• Self Assessment covers:

-Risk Identification through questionnaire and workshops
-Risk assessment through assessment templates, assesses
frequency and severity of loss.
-Control Assessment through assessment templates to understand
the residual risk profile of unit

23
Developing an Appropriate Risk Management
Structure

Board of Directors

Risk Management Committee

Senior Mgt
Risk Mgt

Internal Auditors

Operations Personnel and Risk Takers

24
 Something Different about Operational
Risk

• Market risk managers are more concerned with the size of

losses rather than their frequency.
• In Credit risk management the concern is with the frequency
of default increases.
• An Operational risk model includes the frequency and
severity that can be applied to find the aggregate distribution
for frequency and severity.
• Moreover, operational risk is measured by observed losses
(or historical losses) coupled with qualitative assessment
(RCSA+KRIs) rather than changes in MTM (mark to market)
value.

25
 Capital Charge as per Basic Indicator
Approach
March 2008 March 2009 Difference
Allahabad Bank 299.63 332.39 -32.76
Indian Bank 293.44 341.59 -48.15
Indian Overseas Bank 446.85 446.85 0.00
Punjab National Bank 974.62 1165.60 -190.98
Syndicate Bank 339.74 359.48 -19.74
State Bank Bikaner & Jaipur 201.95 201.95 0.00
State Bank Of India 4531.79 4972.00 -440.21
State Bank Of Mysore 137.58 155.47 -17.89
State Bank Of Patiala 199.95 213.92 -13.97
State Bank Of Travancore 195.52 200.79 -5.27
Catholic Syrian Bank Ltd. 28.91 30.87 -1.96
Axis Bank Ltd 270.31 431.46 -161.15

26
 Particulars Mar-07 Mar-08 Mar-09
Net profit 1026.46 1435.52 2227.2
(+) Add - Provisons and contingency 1388.54 1593.03 2077.8
(+) Add – Operating expenses 2544.31 2934.29 3576.06
(A) SUB TOTAL 4959.31 5962.84 7881.06
(-) a) Reversal during the year in respect of provisions made during the previous year. 3.73 0 6.36

(b) Reversal during the year in respect of write offs madfe during the previous years 259.9 363.33 263.15

(-) Income recognised from the disposal of items of movable and immovable property 12.85 0.37 -0.04

(-) (a) Realised losses from sale fo securities in the 'held to maturity' category 0 0 0.-0.84
(b) Realised losses from the sale of sevurities in the 'held to matrutiy' category 14.32 84.65 724.48
(-) Income from legal settlements in favour of the bank 0 0 0
(-) Other extraordinary or irregular items of income and expenditure 0 0 95.01
Income derived from insurance claims in favour of the bank 0 0 0
(B) Sub - total (-) itmes (iii) to (viii) 290.8 448.35 1088.12
Net [(A) - (B) ] Profits 4668.51 5514.49 6792.94
Profits for 3 years 4668.51 5514.49 6792.94
Gross income for 3 years 16975.94

Multiplied by 15%

27
Capital Charge 848.79
28