Operational Risk Management System

CHAPTER: 2

REVIEW OF LITERATURE

=================================================================

Various articles appeared in different journals on various aspects of operational risk but they are restrictive in nature and do not give a comprehensive picture. A brief review of some of the relevant literature is as under:

Adrian (1999) examined the use of advanced probability models to evaluate risks and justify the decisions where reliable data is available, e.g. reinsurance, money markets and nuclear energy. In the first part, observations are made about the factors shaping operational risk management: the increasing shift of influence from tangible to intangible variables; the intuitive manner in which most operational risk is managed;

(2006) analyzed the capacity of response of the banking sector’s information systems (IS), in the light of the new requirements of Basel II (Basel Bank for International Settlements) on the measurement and control of operational risk (OR). By means of a structured case, developed with a Spanish savings bank of medium size, an analysis was made of the practices and structures that may need to be modified to prevent a loss of competitive position. Specific improvements were proposed to facilitate the implementation of an operational risk information system (OR-IS). The study concluded that there still exists a considerable distance between the current IS in use and an OR-IS compatible with the model proposed under Basel II, for that kind of entities, and indicated the opportunities and incentives that would arise in the attempt to reduce this distance. The IS of a bank should evolve towards the achievement of an OR-IS that enables the bank’s competitive position to be strengthened. In addition, the bank should aspire to obtain the external validation of its supervisory authority, which certifies the OR-IS implemented and classifies it as an advanced measurement approach (AMA) under Basel II. An analysis was made of the principal organizational weaknesses and necessities that should be rectified; with a view to applying the methodologies designated the AMA to OR in the Basel II agreement. Basel II had given increased visibility to the “OR” variable and there

Particular interest was paid to the impact of the financial crisis and the proportion of capital held by the banks depending on how they measured the exposure to operational risk as well as in relation to their exposure to credit and market risk. It was found that most of the banks were using the default approaches provided by the regulatory body as it did not pay off to use a more sophisticated approach. The use of more advanced approaches depends primarily on the size of the banks, but also its ownership. Finally, there is a strong relationship between the banks’ choice of operational risk approach and their regulatory approach used for measuring exposures to credit