OPERATIONAL RISK
MANAGEMENT
Presented by
Sweta Vijuraj

Take away…
What is Risk Management?
 What are the types of Risk?
What is Operational Risk?
Why Operational Risk Mgt ?
How to identify & monitor Operational Risk?
How to measure Operational Risk?
How to mitigate and control Operational Risk?

RISK MANAGEMENT
 Risk – probability of a loss or of a danger. The concept of risk
combines the probability of an event occurring with the impact that
event may have & its various circumstances of happening.
 Risk Management (RM) is the identification, assessment, and
prioritization of risks followed by coordinated and economical
application of resources to minimize, monitor, and control the
probability and/or impact of unfortunate events or to maximize the
realization of opportunities.
 RM is thus a tool to create business value through an integrated
process of identification, estimation, assessment, and controlling
risks.
 Defined as the complete set of policies and procedures which
organizations have in place to manage monitor and control their
exposure to risk

RISK MANAGEMENT
 Its main objectives are to protect the institution from
unacceptable losses, to make optimal use of capital
 It has assumed lot of importance in present scenario when
there is heightened awareness of risk.
 More than a regulatory reporting exercise.
 Should not be viewed as a defensive activity.
 Requires Senior Management’s involvement.

Types of Risks
 Credit Risk - Default risk, Concentration risk, Country
risk
 Market Risk – Interest rate risk, Currency risk, Equity
risk, Commodity risk
 Operational Risk - Legal risk, Model risk
 Liquidity Risk – Asset liquidity, Funding liquidity
 Strategic Risk
 Reputational Risk
 Systemic Risk

Basel I
 The first Basel Accord, known as Basel I, was issued
in 1988 and focuses on the capital adequacy of
financial institutions.
 Originally developed to cover credit risk capital
requirements.
 Assets sorted into four categories based on risk
exposures.
 8% capital requirement.
 Amended in 1996 to include market risk capital
requirements.

Basel-II
 Basel II - Introduced in 2004, as
Introduction
Basel I - the existing framework introduced in 1988 -
• Basel I felt to be inadequate for evaluating the
felt to be inadequate for evaluating the risks in the evolving financial system
risks which was in becoming the evolving more complex, financial innovative and system diversified.
which was
becoming Hence Basel II was developed more as the complex, answer to this requirement.
innovative and
diversified.
• Hence Basel II was developed as the answer to
this requirement.
Basel II addressed not only credit & market risk
capital but also operational risk capital.

Basel II – the Three Pillars
Basel II
PILLAR 1 PILLAR 2 PILLAR 2
Pillar I
Minimum
Capital
Requirement
Pillar III
Market
Discipline
(Disclosure)
Pillar II
Supervisory
Review
Process
Rules
To Calculate
Required Capital
Increased
Supervisory
Power
Increased
Disclosure
Requirements

What is Operational
?

Just think of the following scenarios –
 What if your signature was forged on your stolen cheque and amount was
fraudulently withdrawn from your account,
 Suddenly the bank’s branches close for a few days on account of floods,
 The system server is down during the peak working hours,
 Your fund transfer was successfully done but transferred to the wrong
account,
 Busy operations in dealing rooms of major banks come to a halt?

Global OR Events (External)
Catastrophic losses on account of OR Events (External):
i)9/11 - Terrorist attack on WTC
(2001)
ii)26/07 – Mumbai Floods
(2005)
iii)26/11 – Mumbai Terror Attacks
(2008)
iv)11/03 – Japan – Earthquake, Tsunami
(2011) and Nuclear Crisis

Global OR Events (Financial losses)
Financial Losses due to OR Events :
ii)1999 – Ketan Parekh Scam –Illegal borrowings from GTB &
others by pledging shares as collaterals (GTB collapse)
iii)2008 – Societe Generale – 2nd largest Bank in France
lost € 4.9 bn by the fraudulent future trader
iv)2009 – Satyam Scam – Fudging of accounts by its
founder – Biggest Corp Fraud of Rs.8000 crores
v)2010 – Citibank Fraud –Mutli-crore (Rs.400 cr) fraud by RM
– luring HNIs to invest in bogus Invst schemes –36%
vi) 2013 - Cybercrime syndicate committed fraud through compromised POS
terminal across Europe. 36000card holders in 16 countries affected
vii) 2013- USD 45 million prepaid card fraud. (2 Middle East banks affected)
viii) 2014 – INR 250 crores scam in public sector Bank in India wherein the branch manager
and a private person allegedly took loan using forged documents on behalf of seven private
companies which had deposits in the bank.

Example
Barrings Bank – The incident involved loss of roughly $1.25 bn
due to unauthorized trading activities during 1993 to 1995 of a
single, relatively junior trader named Nick Leeson.
Leeson, who was supposed to be running a low-risk limited return
arbitrage business for Barrings in Singapore, was actually taking
increasingly large speculative positions in Japanese stocks &
interest rate futures and options. He was taking positions on
behalf of fictitious customers, booking losses to non-existent
customer accounts.
Losses happened because of movement of market variables not
in favour of Leeson’s positions. – Market risk vs Ops risk?

Ops risk losses often contingent on
market movements.
This particular case is classified under Operational Risk
because it involved –
 Fraud - Unauthorized trading (Internal fraud), forging
signature, non disclosure, criminal breach of trust etc.
&
 The Failure of Internal Controls
• No clearly laid down reporting lines
• Several managers responsible for monitoring Leeson’s
performance did not do their job (Not questioning the
unexpected sources of profit )
• No segregation of front and back office activities
• No comprehensive review of Leeson’s funding requirements

How Operational Risks is defined?
Basel II has defined Operational Risk as - “ the risk of
loss resulting from inadequate or failed
- internal processes,
- people and
- systems or
- from external events”.
Basel II has clarified that OR includes legal risk but
specifically excludes strategic & reputational risks.

OR Management – Why?
Why Operational Risk Management (ORM)?

ORM – Why?
 It has been believed that banks are exposed to two main risks - Credit risk
and Market risk
 Serious changes in the global financial markets in the last 20 years have
caused noticeable shifts in banks’ risk profile – globalization and
deregulation, technological innovation and advances in the information
network, and an increase in the scope of financial services and products –
complex network.
OR occur in the banking industry every day. Most of the losses are small in
magnitude (frequent/predictable/ preventable) and some are severe in
magnitude of loss.
 Loss due to OR events are far reaching and catastrophic

OR - Significant in Recent Years
Economy is fragile
Loss due to OR events are far reaching and catastrophic
Historic OR events exhibit that they are totally distinct from one
another – either globally or in our Bank
 History proves whoever puts in place BCP/Risk Mitigants manage
OR events better than others
Banks need to move towards advanced approaches for calculation
of OR capital
Advanced approaches involve statistical method of calculation of
capital

ORM
The term Operational Risk Management (ORM) is
defined as a continual cyclic process which includes
risk assessment, risk decision making, and
implementation of risk controls, which results in
acceptance, mitigation, or avoidance of risk.

How to identify
& monitor
Operational
Risk?

ORM Tools
 Loss Data Collection Exercise and Analysis
 Conduct of RCSA (Risk and Control Self-Assessment)
exercise.
 Tracking of KRIs (Key Risk Indicators) at Branch level
and Bank level.
 Scenario Analysis

What is loss data?
Loss Data
consist of
Losses
arising due
to
inadequate
or failed
Internal
Process
People
Systems
External
events

Examples of loss data

Collection of loss data
 Historical loss experience provides meaningful information
for assessing bank’s exposure to OR
 The Bank undertakes the Loss Data Collection exercise on
a half yearly basis and has loss event data base since 1st
April 2008
 Analysis of Loss data is undertaken by RMD on a half-yearly
basis and the findings along with mitigation measures are
submitted to CORM/R.Com
 LDRT (Loss Data Reporting Template) introduced since
01.01.2012 for Reporting/Accounting of OR Loss incidents
 Tracking OR loss incidents on real-time basis through SAS
OR Monitor (EGRC)

Mapping Of Loss Data As Per Basel Business Lines
Loss event type
classification
EL1 EL2 EL3 EL4 EL5 EL6 EL7
BUSINESS LINES Internal
Fraud
External
Fraud
Employment
practices &
workplace
safety
Clients,
Product
s & Buz
Prac
Damage to
physical assests
due to natural
disaster
Business
disruption
& System
failures
EDPM
Corp Fin BL1
T & S BL2
Retail Bkg BL3
Comm. Bkg BL4
P & S BL5
Agency Serv BL6
Asset Mgt BL7
Retail Brkge BL8

Measuring OR - Findings
Major Frauds,
Natural Disasters (such as Fire,
flood, Earthquake),
Terrorist attack etc.
High Impact
Minor accounting errors, leakage
of income, routine mistakes
(available from internal audit)
Low Impact
Low Frequency High Frequency

Risk and Control Self Assessment (RCSA)
RCSA is a risk management program where risks and controls are
examined and assessed to provide reasonable assurance to management
that business objectives will be met.
Steps:
1. self assessment exercise - list out all activities that are susceptible to
OR - List out the main business lines, products/processes in each of
these business lines, then list out the risks associated with each of
these products/processes (combination of experience, judgement,
intuition and past losses)
2. Evaluate: Risk (in terms of frequency and severity) and arrive at
Inherent Risk
3. Evaluate: Controls (in terms of Control Design Effectiveness & Control
Operating Effectiveness) and arrive at Residual Risk.

Key Risk Indicators (KRIs)
RCSA exercise helps in identification and design of appropriate Key Risk
Indicators (KRIs).
(KRIs) are early warning signals, which enable management to monitor
and mitigate operational risks that are reaching beyond acceptable levels.
Example of KRIs would be –For branches; number of days, day end cash
did not tally, number of days cash retention limit was breached, number of
days ATM cash tally did not happen.
 They also provide a backward looking view on risk events, so lesson
can be learned by the past.
 They are one of the Basel recommendations for Sound Operational
Risk Management.

Tracking of KRIs - How it is done ?
 Bank level KRIs : Presently 15 KRIs covering Treasury, IT and
HR tracked quarterly by the respective departments.
 Branch level KRIs : Presently 25 KRIs covering domestic
branches tracked quarterly by Concurrent Auditors and ZO Risk
Management Cell Officials. 20 KRIs covering foreign branches.
The Branch level KRIs helps in identifying High/ Medium/Low
Risk Rating branches.
 The KRIs are tracked and reported to Operational Risk
Management Cell in RMD who in turn analyze the results and
report to the Senior Management.
 Zones are also advised to conduct workshops to sensitize high
risk branches in order to strengthen internal control measures
in these branches.

How to
measure
Operational
Risk?

Measuring Operational Risk
 Operational Risk is comparatively difficult to
quantify.
 However, as Operational Risk impact is positively
correlated with income size and dispersion of
business units – capital charge for OR is
calculated as %age of Gross Income

Calculation of Capital Charge on OR
Basel Committee on Banking Supervision [BCBS]
has put forward three methods for calculating
operational risk capital charge:
Three approaches –
Basic Indicator Approach (BIA)
The Standardised Approach (TSA)
Advanced Measurement Approaches (AMA)

Three Approaches for ORCC
Basic Indicator
Approach (BIA)
Average of
Gross
income for
three years
as indicator.
Capital
charge
equals 15%
of the
indicator.
The Standardized
Approach (TSA)
Gross income per
regulatory line as
indicator.
Depending on
business line 12, 15
or 18% of the
indicator as capital
charge.
Total capital
charge equals sum
of charge per
business line.
Advanced
Measurement
Approach (AMA)
 capital charge
equals internally
generated
measures based on
Internal loss data,
External loss data,
Scenario analysis
and BECIFs .
Recognition of
risk mitigation -
insurance – upto
20%

Capital Charge computation under TSA
• Gross Income = Interest Income + Non Interest Income (-)
Interest expense

Usage of GI as proxy indicators
 BIA and TSA – simpler approaches - but charge more
capital.
 Risk indicator based on income level (Gross Income)
and not on risk exposures.
 BIA- one size fits all, doesn’t consider risks separately
for different activities.
 TSA: Ambiguity in BL descriptions – activity allocations
to Business Lines (BL) with lower Beta.
 Negative Gross Income allowed to be off set against
positive.

Inputs for AMA
Under AMA, banks are required to incorporate four key data
inputs/elements in capital modeling:
1) Internal loss data
2) External loss data
3) Scenario analysis data
4) Business environment and internal control factors
(BEICF)
(BE factors: Employee attrition, Growth factor, Product complexity.
IC factors: RCSA scores, Key risk indicators, Internal audit ratings and
Operational risk appetite.
Estimated capital is scaled up/ down based on BE factors & IC factors).

OPERATIONAL DATA

Modeling Approach in AMA
Being an evolving area, regulators have given
flexibility of selecting modeling methodology to the
banks.
 Some of the Approaches used:
 Loss Distribution Approach (LDA)
 Scenario Based Approach (SBA)
 Hybrid Approach

OpVaR model (illustrative)
Source data Modeling Simulations Aggregation
Internal
Loss Data
External loss data
Scenario Analysis
BEICF
adjustments
Distribution
Fitting
Distribution
Fitting
Frequency
& Impact –
Output:
Simulated
Internal losses
Simulation –
Output:
Combined
Loss value
Frequency –
Output:
Simulated
Scenarios
losses
Bank level
OpVaR
Component VaR
(business line wise)
Adjusted Component
VaR

OR Capital Adequacy-Economic Capital
Eg: If the bank has a Maximum loss (Op Var) of 100 & Expected loss (mean) of 20,
then , Economic Capital = 100 – 20 = 80

LOSS DISTRIBUTION APPROACH

AMA: Key challenges
 Non-availability of historical data in majority of cells and
dependence on scenarios in the absence of India specific external
loss data.
 Incorporation of correlation among scenarios.
 Incorporation and identification of BEICF elements in the capital
computation/allocation.
 Back-testing of OpVaR computation.

How to mitigate
and control
Operational
Risk?

Mitigating Operational Risk
 Damages due to natural disasters, fire, etc – INSURANCE
 Losses from Disruptions – electricity / telecommunication –
BACKUP
 Losses due to internal reasons - STRONG INTERNAL
AUDIT PROCEDURE
 OR Events leading to severe business disruption –
Business Continuity Plans (BCPs)
[Mitigants put in place to be reviewed periodically to ensure
contingency strategies remain consistent with current
operations, risk & threats, resiliency requirement and to
facilitate BC with minimum loss of time.]

Bank Of India – Journey of Corporate Office
1906 1950
1973
2003

Risk Management Architecture in
BOI
Risk Management Architecture

Operational Risk
BOI

OR - Organizational setup [ORMF]
 Board of Directors
 Risk Management Committee of the Board (R.Com)
 Committee for Operational Risk Management (CORM)
 Operational Risk Management Department (ORMD)
 Business Operational Risk Managers (BORM)
 Support Group - Operational Risk Management
Specialist (ORMS)
 RMD set-up at ZOs/LCBs/DOs/Foreign Centres
 Business Line OR Management (Branch Level)

BOI Progress in ORM I – Comprehensive ORM
Policy
The Operational Risk Management policy has been framed
considering various regulatory guidelines issued from time to
time. This policy document describes the approach to
Operational Risk Management within the Bank as part of
Enterprise-wide Risk Management and also to comply with
the regulatory guidelines.
 ORM Policy covers-
Scope & Applicability
Operational Risk Management Framework – Governance
structure, three lines of defence, roles and responsibilities
Operational Risk Management Process
Capital Measurement
Independent Evaluation
Sound Industry Practice

BOI Progress in ORM II – Business Line Mapping
 Mapping of products to business lines through
Risk Registers
Bank`s total products(aggregating more than 100
in Deposits, Advances, Remittances &
Miscellaneous Services have been mapped to
Business Lines as per Basel II norms
 Mapping of income & expenses for capital
charge computation under TSA – automated
using SAS

BOI Progress in ORM III - RCSA
Risk & Control Self Assessment (RCSA)
 11 Risk Registers covering all the products and
processes in all the Business Units and Support
functions have been prepared to aid in Risk and
Control Self Assessment (RCSA) exercise.
 RCSA exercise done online using SAS system.
 Sample Retail Banking Assets Risk register

BOI Progress in ORM IV - KRIs
Key Risk Indicators (KRIs)
 Key Risk Indicators (KRIs) are revised based on the RCSA results
and in all there are 60 KRIs (15 Bank level, 25 Domestic branch
level and 20 Foreign branch level).
 Revised KRIs are tracked and analyzed and reported to Senior
Management on a quarterly basis.
KRI examples

BOI Progress in ORM V – Loss data collection
Loss Data Collection
 Loss data reported using “Loss Data Reporting Template
(LDRT)”
Reporting process will be automated with help of SAS
from January 2014.
 Loss accounted using Finacle P&L Heads: PLOE061
(frauds) & PLIP034 (non-frauds)
 Loss data collection since 2008. We have six years loss
database.

BOI Progress in ORM VI – Analysis of high value loss events
Analysis of high value loss events
 Fraud analysis is undertaken on a periodical basis
by Fraud Risk Management Department.
 Operational Risk Management Cell analyses loss
events above Rs.50 lakhs in terms of failure of
controls, systems, process and people and
suggests mitigation measures to control/prevent
such loss events. This analysis is then reported to
the Senior Management .

BOI Progress in ORM VII – BCP & DRM
Business Continuity Plan
Disaster Recovery management
 Bank's Data Center is located at CBD Belapur and DR
site in Bangalore which are in different seismic zones.
 Data at both the sites is always in mirrored status which
ensures uninterrupted services to customers.
 Bank has Global Processing Center at Singapore for all
overseas centers which ensures centralized monitoring
of transactions

BOI Progress in ORM VIII - Audit
Risked Based Internal Audit
Bank has migrated to Risked Based Internal Audit
from 01/04/2007 and the assessment is being
done based on exposure of the branches to
various types of risks like Operational Risks,
Credit Risks, Compliance Risks, Earning Risks.
Technology Risks etc. Suitable mitigating
measures are initiated immediately on the receipt
of requisite report.

BOI Progress in ORM IX – IT Risks
IT Risks & Cyber Crime prevention
 Bank has put in place comprehensive
Information System Security Policy.
 Bank has appointed Chief Information System
Security Officer dealing exclusively with the
system security and risks related to IT and cyber
crimes.
 Bank has introduced Information Security Portal
on Bank's website which alerts all concerned
about the IT Risk threats on an ongoing basis.

BOI Progress in ORM X
New Product Group
Any new product/process is first passed through a
Sub-Group called “Product Group” before
submission to Committee on Operational Risk
Management (CORM) for clearance and to
ED/CMD/Board for approval.
Risk Assessment Questionnaire for New Product/Process

BOI Progress in ORM XI
KYC & AML Policies
 Bank has put in place elaborate KYC &
AML policies
 KYC is being done for deposit & credit
customers as well as those effecting
remittances from the Bank
 The Bank has also purchased AML
software

BOI Progress in ORM XII
Employee Fraud Prevention
Maker Checker concepts & Dual Control
Adequate Remuneration & compensation to
staff commensurate with performance
Various Staff incentive schemes
Appropriate Training & Guidelines
Documented Service conditions & Service
Regulations

BOI Progress in ORM XIII
Unauthorized Activity Control
 Laid down procedures & guidelines
 Delegated Powers for credit & Non credit
matters
 System of Noting & Reporting of
sanctions to next higher authority

BOI Progress in ORM XIV
Employee Practice & Work Place Safety
 Documented HR Policy for appointment,
transfer, promotion, placement and
overseas posting
 Adherence to all local labour & industrial
laws
 Proper Succession Planning
 Redressal of staff grievances through
welfare committees
 Direct communications to staff by Top
Management

BOI Progress in ORM XV
Outsourcing Risk Management
 Laid down procedures for selection of
panel of vendors
 Fool Proof agreement documents
 Periodic Review of outsourcing
arrangements
 Customer/Shareholder complaint
redressal mechanism

BOI Progress in ORM XVI
Security Measures:-
 Effective security measures put in place
to safeguard banking assets
 Security Guards, CCTVs, Burglar
Alarms, Smoke Detectors, Fire Proof
vaults and cabinets for documents
storage, insurance etc.

BOI Progress in ORM XVII
Ops Risks embedded in other risks :-
 Cash Management – Cash retention limit, Cash van
management including transit insurance, Counterfeit
notes
 Credit Mgt-Timely review & inspections, Vetting of
documents by advocates, Up to date maintenance of
mortgage register
 Treasury Mgt – Front & Back office control, Exposure
limits, Stop Loss limits
 Investment Mgt – ALCO committee for fresh
investments/review of existing investments.
 Marketing –Deployment of trained staff with full
product knowledge

To Summarize…
 Operational Risk if the most important of all risks as it involves
managing the unknown! Most difficult to quantify & manage!
 ORM framework must be closely integrated into the day-to-day
risk management processes of the bank.
 Use ORM tools (loss data, RCSA, KRI) to gather information
and perform analysis to report findings to Senior Management
for business decision making.
 ORM to identify those risks which needs to be taken and those
which needs to be insured.
 Spreading Risk culture in the Organization is important for
successful implementation of Operational Risk Management
Framework in the Organization.

My Contact Number :-
Direct :BOI -HO RMD 022 66684974
E mail : sweta.panangadan@gmail.com
sweta.panangadan@bankofindia.co.in