Operational Risk Country Risk

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					 Risk Management
Through Governance

    Managing Director
      Gaia Advisors


Governance is concerned with the system of law,
regulations and practice which will promote the
enterprise and ensure accountability.

 Pillars of Governance     Constituents
  Transparency             Owners
  Accountability           Board
  Responsibility           Managers
  Integrity                Employees
                            Other Stakeholders
  Key Decisions Variables
                         Risk Management

                                                     Interest Rate
Credit Risk
                          Profitability              & Other Market
                          &                          Risks
                          Market Value

       Capital Account                     Productivity/Cost &
       Management                          Operational Risk

 Appropriate Balance-
 Expected Profits and Risk

                                 risk         Overhead
 Liquidity and
 funding risk                                             Foreign
                                                          currency risk

Inflation                       Expected                          Reputation
risk                            profits                           risk

     Interest                                                Credit
     rate risk                                               risk
                 Operational                   Solvency
                 risk             Market       risk
Risk categories and their importance for MFI
Risk categories                          Rating

Credit             Loan portfolio risk   XXXXX

                   Interbank risk        XX

Market             Interest rate risk    XXXX

                   Currency risk

Liquidity          Liquidity risk        XXXXX

Other risk         Performance risk      XXXXX

                   Compliance risk       XXXXX

                   Reputation risk       XXXX

                   Country risk

Operational risk   Operational risk      XXXXX
Operational risk is every MFI's greatest fear.

    Credit Risk        Staff        Human Error

                               Disbursements /
            Control Failures
                               Re payments
       Compliance          Management System Failures
                                  Legal        Premises
   Rapid Expansion
                               Business Continuity
                  Information Technology
    Fraud                                    Market Risk
Operational Risk

•   Circumstances that have been identified and if left
    unattended may lead to a loss in the future, example :

•   Happening or occurrences that are indicative of the
    underlying risk, they might have resulted in an economic
    loss, but did not, example : large cash balances; no
    monetary loss yet

•   Incidents that resulted in a monetary loss Example: Small
OR can arise from:

   Internal and external fraud
   Failure to comply with laws or meet workplace safety standards
   Policy breaches
   Failure to meet regulatory requirements
   Personnel risks
   Damage to physical assets
   Business disruptions
   Transaction processing failures (execution, errors)
   Failure of internal controls and corporate governance
But how do you define, analyze and solve a
potential problem before it has even arisen?
“ Operational Risk is the risk of loss resulting from inadequate
 or failed internal processes, people and systems or from
 external events”

  Operating Environment
But how do you define, analyze and solve a
potential problem before it has even arisen?

  External Events
  Includes legal risk but excludes strategic risk
Operational risk (OR) – People Risk

    OR is more than people and technology risk. It encompasses all the hidden dangers
    that do not come under the umbrella of market or credit risk.

   Positing of Staff in Key Areas
   Competency of Staff
   Insufficient training,
   negligence, integrity, etc.
   Work Environment
   Employee Motivation
   HR initiatives
   Frequency and impact of staff turnover/rotation
Operational risk (OR) – Process Risk

 Transaction risk:
 ◦   Operational Manual to execute Transaction
 ◦   Frequency of execution of errors in transactions
 ◦   Business volume fluctuation/ concentration
 ◦   Organizational complexity
 ◦    Product complexity, and major changes

 Operational Control risk

 ◦   Frequency of Violation of operational controls ( exceeding limits, powers)
 ◦   Efficiency of information flows
 ◦   Frequency of operational disruption
 ◦   Operational Control: inadequate segregation of duties
 ◦   lack of management supervision
 ◦   inadequate procedures.
 ◦   Risk due to loose security at operational points ( overnight cash)
Operational risk (OR) – Technology Risk

   Poor technology and Partial /disconnect computerization
   Obsolete applications
   lack of full automation for consolidation and /or accounts and Operations
   MIS complexity, poor design, development and testing.
   Systems failure
   Volume of transaction Vis-a- Vis level of system development and capacity
   Level of Manual intervention required to process transactions
   Validity of IT systems
   IT related frauds
Operational risk (OR) –

Reputation risk
   Customer perception of the Company/MFI
   Mostly dependent of Field officer
   Individual is recognized than the institution by the customer
   Public /Politicians perception of MFIs

Operating Environment
   Unanticipated changes in external environment
   Multiple lending
   Macro Economic Factors like loan waiver, low fund flow to MFIs leading to failure to
    keep up commitments to customers
Operational Risk - 7 OP Risk types

    Internal Fraud

    External Fraud

    Employment Practices

    Professional Practices

    Loss/Damage to assets

    Business disruption & system failures

    Transaction processing risk
       Interconnection of Operational Risks

Dependencies   Internal    External

 Operational                               Risk
               People       Process      Exposure

                                        Likely drivers
                                        of Operational
               Change     Complexity   Risk associated
 Sources                                   with each
                   Complacency         Operational Risk
Risk types contd…

   Internal fraud: intended to defraud, misappropriate property, employee
   External fraud: robbery, forgery, Collusion.
   Employment practices and workplace safety: workers compensation
    claims, organized labor activities likely
   Business disruptions and system failures: hw. and sw. failure.
   Execution, delivery and process management: data entry errors,
    incomplete legal documentation, unapproved access given to client accounts.
How can we addressing Operational Risk?

   Transfer the risk to another party (e.g. through insurance)
   Accept and manage the risk through effective management
    monitoring and control
   Put appropriate fall-back plans in place to reduce the impact
    in case of an operational failure.
   Least- Avoid the risk by withdrawing from a business activity
OR Management

   Risk Management systems-adequacy, demarcation of
    responsibilities, day-to-day supervision
   Areas- Cash management, internal control &
    housekeeping, AML controls
   Robust internal control-
   Effective internal Inspection/Audit
   KYC & AML measures-emphasis
ORM Practices should be based on policy duly approved
at the board level that describes the processes involved
in controlling OR.
   Clear strategies and oversight by the Board: Board of Directors
    should approve and review the MFIs ORM framework.
   Internal Control System: ORM framework is subject to effective internal
    audit by operationally independent and competent staff.
   Strong Operational Risk Culture: ORF should be implemented
    throughout the whole organization, all levels of staff should understand their
   Contingency Planning: MFIs should have contingency and business
    continuity plans to operate on an ongoing basis and limit losses.
   Effective internal reporting: Senior management have responsibility for
    developing policies, processes and procedures for managing OR.
        Issues in ORM

 Qualitative vs Quantitative approach
 Mapping of existing business lines to the standard business
 Data collection
       Proper identification of key risk indicators
       Monitoring of databases
       Gathering loss data
       Estimating frequency/severity of loss
 Quality of data
 Cost/technology implications
 Overlap with Credit and Market Risk
Distribution of Operational Losses
           Expected         Unexpected             Catastrophic
         Loss-Loss Prov.   Loss -Op. Risk   Loss -Risk financing using
           Absorbed           Capital              Core Capital


                           Magnitude of loss
Expected Loss

   Expected Loss (EL) - likelihood of failure and likely loss
severity given that a failure occurs
   Exposure Indicator (EI) - proxy for the size of a particular
business line’s OR exposure
 Probability of loss Event (PE) - probability of occurrence of
loss event
 Loss Given that event (LGE) - proportion of transaction or
exposure that would be expressed as loss, given the default

                       EL = EI X PE X LGE


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Description: Operational Risk Country Risk