Scribd
Upload
8 views1 page

Understanding Operational Risk in Banking

Operational risk encompasses the possibility of loss due to inadequate or failed internal processes, people, systems, or external events, as defined by the Basel Committee on Banking Supervision. It includes legal risk but excludes reputation and strategic risk, and is considered an inherent part of banking operations. Historical examples, such as the Barings Bank failure, illustrate how operational risk can lead to significant losses, often intertwined with credit or market risks.

Uploaded by

Er0do Gaming
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as TXT, PDF, TXT or read online on Scribd
8 views1 page

Understanding Operational Risk in Banking

Operational risk encompasses the possibility of loss due to inadequate or failed internal processes, people, systems, or external events, as defined by the Basel Committee on Banking Supervision. It includes legal risk but excludes reputation and strategic risk, and is considered an inherent part of banking operations. Historical examples, such as the Barings Bank failure, illustrate how operational risk can lead to significant losses, often intertwined with credit or market risks.

Uploaded by

Er0do Gaming
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as TXT, PDF, TXT or read online on Scribd

So what is operational risk? Is it the risk arising from Operations? i.e.

mistakes
committed while undertaking Banking transactions. What about frauds committed by a
third party or losses due to a fire, an earthquake or a pandemic?
All these aspects are covered in the definition given by Basel Committee on Banking
Supervision for Operational risk: Operational Risk is defined as possibility of
loss due to inadequate or failed
Internal Processes People Systems Or External Events. It includes Legal Risk but
excludes Reputation Risk and Strategic Risk
Unlike Credit Risk or Market Risk, where Banks make a conscious decision to take a
certain amount of risk, Operational risk is all pervasive, it is considered as a
necessary part of doing business.
Now if we look back in history, we see that many of the Bank failures and big
losses resulted from Operational Risks. Many a time the failures or losses happen
due to a combination of Operational risk with Credit or Market risk.
Let us look at the Barings Bank example which we discussed in Module II, the Bank
was brought down by the activities of One single rogue trader, Nick Leeson. The
losses that Nick Leeson incurred were trading losses which could be classified as
Market Risk.
However, the reason for the trading losses was breach and even lack of Internal
Controls which let Nick Leeson keep incurring losses and hiding them for quite some
time. This is therefore a fraud and hence an Operational Risk. A point that we need
to note here is if the market had not moved against Leeson, there would have been
any loss.
Hence despite the breach in Controls the fraud would never have come to light.
Similarly, if some mistakes are made while in loan documentation, losses due to
these mistakes will occur only if the borrower defaults.

You might also like