Although banks are required to hold regulatory capital to reduce the risk of bankruptcy from an operational risk event, banks also have to have internal policies and structures to reduce the risk of operational risk events occurring within their organization.
The Basel Committee on Banking Supervision has also published a set of principles which it feels are relevant for banks to consider when determining how operational risks are managed within their organization.
We'll look at each of these principles. In turn.
The first principle is a strong risk culture.
With a strong culture of risk management and ethical business practices, banks are less likely to experience damaging operational risk events and a better placed to effectively deal with those events that do occur.
Since people working within an organization have been found to take their lead as to what is acceptable from management of that business, the board of directors should take the lead in establishing a strong risk management culture, which is then implemented by senior management.
The board of directors should establish a code of conduct or an ethics policy to address conduct risk.
This code or policy should be applicable to both staff and board members.
It should set clear expectations for integrity and ethical values of the highest standard.
It should identify acceptable business practices and prohibit conflicts of interest or the inappropriate provision of financial services, whether willful or negligence, to clearly demonstrate to all employees what standards of behavior are expected within an organization.
The next principle is that banks should have a comprehensive operational risk management framework.
The board of directors and bank management should understand the nature and complexity of the operational risks inherent in its portfolio of products, services, activities, and systems.
This is a fundamental premise of sound risk management.
Banks should develop, implement, and maintain an operational risk management framework that is fully integrated into the bank's overall risk management process.
However, the framework adopted by an individual bank will depend on a range of factors, including the nature of a bank's products, its size, its complexity, and its risk profile.
