Page 211 - DCAP304_DCAP515_SOFTWARE_PROJECT_MANAGEMENT

Unit 10: Risk Management

Notes
Depending on the size, complexity and organisational structure of bank, a five-step
approach can be used for building a robust op-risk framework:
 Identification of operational risk through event framework
 Analysing the causes of events
 Risk mapping

 Risk measurement and control
 Management of operational risk and, thereby, capital management.
To start with, banks, as part of identification, should classify and capture all operational
losses in the form of “events”. Events are nothing but “occurrences” or “happenings”.
Banks should start accumulating data on events that have occurred in the past and also
identify potential events.
All events should be defined with attributes, such as, frequency of event, severity, loss
amount, reason for loss, date of discovery of loss and date of occurrence.

Banks can adopt the seven type of events suggested by Risk Management Group (RMG) of
Basel committee for one of their quantitative studies (QIS-2) which includes internal fraud,
external fraud, employment practices and work safety, client products and business services,
damages to physical assets, business disruption and system failures and execution delivery.
The second step involves doing a causal analysis to understand the exact cause for the
above events and estimate the actual loss as well as potential loss in case the events are
repeated. This analysis on cause of events can make the bank understand the level of
exposure and the op-risk management strategy it needs to adopt.
Once banks have developed an event database and done the causal analysis, they can start
risk mapping. Risk mapping is a tool wherein banks can map the above risk events and
losses to any specified set of business lines.
Basel has come out with eight set of business lines — corporate finance, trading and sales,
retail banking, commercial banking, payment and settlement, agency and custody services,
asset management and retail brokerage — to which the events collected by bank can be
mapped.
Op-risk measurement is still evolving in terms of tools and techniques that can be used for
effective measurement and management. Banks can follow either or both of qualitative
risk measurement or quantitative risk measurement.
The generic ways of measuring op-risk include qualitative risk measurement techniques
such as critical assessment method, which involves questionnaire format and interviews
with all line managers to identify the op-risk events.

Another widely used approach, which is a combination of qualitative as well as quantitative
approaches, is the Key Risk Indicators (KRI) approach, which involves identifying
indicators, which convey good idea about the scope of business and thereby the risk
involved.
For instance, portfolio size, volume of transactions traded, volume of deals routed through
payment and settlement systems, etc., form one set of predictive indicators. KRI is more a
predictive model than a cause-and-event approach.

A common quantitative approach used is Loss Distribution Approach (LDA), which
involves arriving at a right fit distribution of historical loss events and, thereby, at
quantitative results like expected loss and finally operational value at risk.
Contd.....

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