BFM FREE NOTES ON OPERATION RISK | STUDY MATERIAL FOR CAIIB BFM EXAM 2022
In this article, you are provided with the free notes on BFM topic from the prescribed CAIIB Syllabus of 2022 i.e Operational Risk.
As Steve Job has said, “Learn continually – there’s always ‘one more thing’ to learn!”, we are here with another free short note on one of the topics of Bank Financial Management from CAIIB Syllabus 2022. We have tried to explain the topic of ‘Operational Risk’ as clearly as possible so that you can remember the concept after one read. So, here goes nothing.
WHAT IS THE MEANING OF OPERATIONAL RISK?
It is one risk which is faced by almost every organization. This risk depends only on the complexity of the organizational structure. The More Complex the structure of an organization is, the more it would be prone to operation risk.
It is usually seen that operational risk arises on account of deviations from normal and planned activities, procedures, technology & human failures of omission and commission.
CLASSIFICATION OF OPERATIONAL RISK
Before we proceed to classify the operational risk, we need to understand its nature of operational risk.
In the literal sense, operational risk can advise on account of any activity which is being undertaken. Therefore, it would not be wrong if we are to say that operation risk is present everywhere in the organization.
Impact of operational risk: This risk may vary in degree on account of different activities.
Nature of Operational Risk:
- Operational risk is present everywhere in the organization
- It may vary in its components as with some activities it might have high chances of occurrence but the risk may be low while with some other activities, it might have low chances of occurrence but the risk associated with the activity may be high.
- Operational risk keeps on changing along with the changes that happen in the organization.
| SYLLABUS | STUDY MATERIAL | NOTES | MOCK TESTS |
| CAIIB Risk Management Syllabus 2022 | CAIIB Risk Management Study Material PDF 2022 | CAIIB Risk Management Notes PDF 2022 | CAIIB Risk Management Mock Test PDF 2022 |
Classifications of operational risk
Classification of operational risk can be based on the causes and effects as per the second paper of Basel-II. Which operation risk can be classified as:
Cause based operational risk
| CAUSE | EXAMPLE |
| People oriented causes | Negligence, incompetence, insufficient training, integrity, key man. |
| Process oriented (Transaction based) causes | Business volume fluctuation, organizational complexity, product complexity, and major changes. |
| Process oriented (Operational control based) causes | Inadequate segregation of duties, lack of management supervision, inadequate procedures. |
| Technology oriented causes | Poor technology and telecom, obsolete applications, lack of automation, information system complexity, poor design, development and testing. |
| External causes | Natural disasters, operational failures of a third party, deteriorated social or political context. |
Effect Based Operational Risk
| CAUSE |
| Legal liability |
| Regulatory, compliance and taxation penalties |
| Loss or damage to assets |
| Restitution |
| Loss of recourse |
| Write-downs |
Event-Based Operational Risk
| CAUSE | EXPLANATION |
| Internal Fraud | Losses incurred as a result of acts of deception, misappropriation, or circumvention of regulations, laws, or company regulations, excluding diversity- or discrimination-related events involving at least one internal party. |
| External Fraud | The loss that results from a third-party defrauding, misappropriating or circumventing the law through illegal means |
| Employment Practices and Work Place Safety | Compensation for losses resulting from violations of employment, safety, health, and environmental laws, or compensation for diversity/ discrimination events. |
| Clients, Products and Business Practices | The damages incurred when you fail to meet a professional obligation to clients (including fiduciary duties) unintentionally or negligently An occasional product is built to meet specific requirements (such as functionality and suitability). |
| Damage to Physical Assets | Disaster losses, including those caused by natural disasters or other events that result in the loss of physical assets. |
| Business Disruption and System Failures | Business losses occur when systems fail or when systems are disrupted. |
| Execution, Delivery and Process Management | Incorrect process implementation or management can result in revenue loss due to poor counterparty and vendor performance. |
OPERATIONAL RISK MANAGEMENT PRACTICES
| FUNDAMENTAL PRINCIPLES OF OPERATIONAL RISK MANAGEMENT | |
| PRINCIPLE | EXPLANATION |
| Principle 1 | This principle suggests that the board of directors should take initiative to establish a strong risk management culture where the employees are guided by strong risk management and a culture which sports and provides sufficient standards and incentives when employees behave professionally and with responsibility.
So, this principle suggests that the board of directors is responsible to ensure that a strong operation risk management culture should be there in the whole organization. |
| Principle 2 | This principle suggests that banks should have such a framework which is fully integrated into the processes of bank overall risk management. This framework should also be carefully developed, implemented, and maintained and be dependent on a range of factors such as its nature, risk profile size & complexity. |
| GOVERNANCE: The Board of Directors | |
| Principle 3 | As per this principle, the board of directors needs to establish, approve and review on a periodic basis the Framework that has been established as per the principle-2.
Should also oversee the senior management so that it can be assured that the policies, processes, and systems are getting implemented effectively at all the decision levels. |
| Principle 4 | According to this principle, the board of directors needs to approve and review the articulated risk appetite and tolerance statement for operational risk. One can understand from this statement – all the information about the nature, type, and level of operational risk that the bank should be willing to bear. |
| GOVERNANCE: Senior Management | |
| Principle 5 | As per principle number 5, senior management is also required to develop a clear and robust governance structure which clearly defines a transparent & consistent line of responsibility.
Senior management should also be responsible for ensuring that the policies, processes, and Systems are consistently implemented and maintained throughout the organization. This is important so that operation waste can be managed in all the bank’s material products, processes, activities, and systems so that it is consistent with the risk appetite and tolerance set by the board of directors. |
| RISK MANAGEMENT ENVIRONMENT: Identification and Assessment | |
| Principle 6 | Senior management is also required to ensure that the operational risk which is inherent in all the material products or activities, processes, and Systems gets identified and assessed so that everyone can understand and incentives. |
| Principle 7 | Senior management is also required to ensure that there exists an approval system or process to assess the operational risk of all the new products, processes, and Systems. |
| MONITORING REPORTING | |
| Principles 8 | Senior management should also monitor the operational risk profiles and material exposes that can lead to losses. To spot the proactive management of operational risk, an appropriate reporting mechanism should also be in place at all the levels i.e. Board level, senior management level, and business line level. |
| CONTROL AND MITIGATION | |
| Principle 9 | There should be a control environment in the banks which utilizes the policies, processes and Systems made for appropriate internal controls and risk mitigation or transfer strategies. |
| BUSINESS RESILIENCY AND CONTINUITY | |
| Principle 10 | There should be business resiliency and continuity in the plans inside the banks so that banks should have enabled to operate on an ongoing basis with a strict limit of losses in case business is severely disrupted. |
| Principle 11 | As per this principle, the stakeholder should be allowed to assess the bank’s approach to operational risk management and that is possible if the Bank makes public disclosures in this regard. |
So, these are some of the fundamental principles of operation risk management which a bank should employ in its institution or structure.
We sincerely hope that you have found the above text easy to understand and should have learned much more than the official text could explain. If you found this article helpful, you can also read our other notes on the bank promotion syllabus 2022
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