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Managing Risks in Commercial and Retail Banking by AMALENDU GHOSH

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CHAPTER 22

Operational Risk Management Framework

22.1 OPERATIONAL RISK CONCEPT

It is difficult to precisely define operational risk (OR) because it has less visibility and often remains hidden in transactions and activities. In contrast, credit and market risks have more visibility and are more easily identifiable and predictable. Operational risk arises from possible failures of the business operation process and the control system of a bank. The Basel Committee on Banking Supervision has defined operational risk “as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk.”1 The Basel Committee definition is based on the happening of certain events that cause loss to the bank but cannot be clearly assigned to default risk (credit risk) or value erosion risk (market risk). For example, misappropriation of cash by dealing staff, unauthorized transactions by front office staff, forging of bank officials’ signatures for false claims against the bank, accounting errors resulting in loss of revenues, and the like are incidents that give rise to operational risk. Significant differences exist between credit risk and market risk on the one hand and operational risk on the other, if we take into account the multiplicity of sources from which risks occur, the number of events that cause loss, and the magnitude of loss that arises if risks materialize. ...

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