Operational Risk: Changing Face of Compliance

Old perceptions and behaviors towards risk are changing. ORM is acquiring new credibility as a roadmap to add value to the business; and is garnering new attention from regulators and key stakeholders.

A recent Chartis Research’s1 report on ORM systems, suggests that the worldwide financial services ORM market will continue to grow, reaching a total value of $1.55 billion by 2011. This indicates a growing concern among banks and financial institutions for managing their operational risk.

There are two main drivers for this development. Firstly, there is a growing acknowledgement from banks that a consistent and effective operational risk management framework can help them achieve organizational objectives and superior performance. For example, by including a well-constructed operational risk process in the entire value chain, a bank can help ensure that the risks inherent in those activities are understood and addressed. In many instances an early involvement of operational risk management can increase the development speed of new initiatives.

The second key development is the launch of the Basel II Capital Accord (the New Accord) by the Basel Committee for Banking Supervision, which requires banks to set aside regulatory capital for operational riskan important development that has affected most financial services institutions worldwide. One of the major improvements in Basel II is that it ensures closer linkages between capital requirements and the ways banks mange their actual risk. As summed up by a U.S. regulator, “The advanced approaches of Basel II represent a sea change in how banks determine their minimum level of required capital for regulatory purposes. It intends to better align regulatory capital with inherent risks and banks’ internal economic capital”

The advanced approach for measurement of operational risk requires economic capital to be calculated on the basis of bank’s own operational risk management & measurement technique. It is imperative to strengthen the soundness and stability of operational risk management practice by employing Advanced Measurement Approach (AMA); in order to ensure that it does not become a significant source of competitive inequity over rival banks & financial institutes. Further, AMA fosters risk sensitive environment and promotes efficiency in managing risk. The road ahead should lead to “Advanced Measurement Approach” (AMA) as described under Basel II accord.