Risk events in the banking sector and financial institutions
can trigger huge losses. Risk events can be managerial, technological, security, and operational. With these operational hazards, the need for protection rises in banks simultaneously. Banks need to function seamlessly, faster, and more accurately in such circumstances.
According to a report by Barclays, prominent banks worldwide have suffered nearly $210 billion in losses from operational risk from 2011 to 2019. Most of these losses were caused by unavoidable errors made by employees and systems when interacting with clients, transactional flaws, and fraud.
Since the global financial crisis, including the pandemic, banks and other financial institutions have become highly observant of their efficient risk management needs. As a result, banks can use techniques to anticipate and fix risk events before or at the right time. However, some strategic risks or challenges still prevail. Let’s understand what those are first!
Strategic Challenges in ORM
Risk management in banks and financial institutions has always been a complex function. Out of which strategic risks are mostly recorded. What are the most prominent strategic risks that banks usually suffer from?
Large & Complex Data Processing
The processing of large and complex data risks puts banks under pressure to monitor exponentially. Most banks still face the challenge of collating extensive customer data, data inputs, processing, and unreliable and dysfunctional tools, which results in the loss of potential clients and fees.
Inefficient Risk Identification Parameters
Most banks do not have risk management tools like KRIs, KCIs, and KPIs. As a result, they are inefficient and do not have a holistic view of the data, which leads to inappropriate risk identification. Further, most banks also do not have consistent risk management protocols across their business, which poses a significant risk to the operational infrastructure of those banks.
Loss of Data Management
Loss of data is also an essential risk that banks face several times. Data management
is an integral part of the banking operation, which means it needs core risk management strategies to keep it secure. Data management includes several functions, but the most essential is maintaining data records securely. This is one of the prime risks that banks, even today, keep a close eye on.
The Current State
While banks have been aware of operational risks, they need to be prompt in adapting risk management capabilities and tools to eradicate the complexities and introduce smoothness in the workflow. Currently, banks have developed taxonomies on risk-identification and risk-assessment processes, extensive controls through cloud support, and cyber and control-testing procedures.
While the banking industry
practically succeeded in reducing the industry-wide regulatory system, there are now fewer losses from operational risks in banks.
"In financial services, if you want to be the best in the industry, you first have to be the best in risk management. It's the foundation for every other measure of success. There's almost no room for error."
John Stumpf, chairman and CEO of Wells Fargo
Integration of ORM Strategies
Evaluate Risk Profile
Every financial institution and bank should assess their risk profile to reduce operational risks and improve information security. It should also evaluate the resilience of its business processes, map them to associated risks and controls, and build a database of potential operational risk events. To facilitate this under operational risk management
, deploy analytics into the process and evaluate potential threats at a particular time. In this way, banks can minimize risk factors in the future.
Introduce Risk Indicators
Most banks examine their sales-operating models meticulously because of regulatory concerns about sales practices, such as product features, incentives, sales procedures, frontline-management routines, and customer-complaint processes.
Risk management in the banking sector can now be possible as banks can enhance their operational risk coverage with the help of the ‘three lines of defense” model. This model is widely used to define and manage operational risks. It is a solution framework that functions at a granular level to help identify and control risks. The target framework should include sources of risk that most banks lack, such as:
A clear definition of accountability at each level of the risk plan
Established levels of communication and feedback from various levels of management
Uniform monitoring of all potential risk exposure sources, such as portfolio management, employee tracking, or even disaster management
The key objective for banks is to move beyond legal risks and focus on all business processes to ensure they are covered fully for the future.
Initiate Training for Employees
Employees play an integral role in managing operations in banks and financial institutions. Therefore, to ensure the effectiveness of the same, employees can be given training on operational risk management programs and functions of management programs to make them aware of the potential risks and ways to overcome them. This is extremely important for those banks and financial institutions looking to launch a new customer interface, roll out new products or services, or adapt new business processes with technology implementation.
Asset management is one of the essential parts of operational risk management in banks and financial institutions. So, for asset management, bank managers should be concerned about two major things—the role of asset management and how to develop a good plan for managing assets. Asset management identifies and manages risks that arise when certain assets are used.
To exclude risks in bank operations, a fundamental strategic asset management plan will include the following six phases:
After these phases have been covered, banks must count their assets. Here is the following inventory of assets that need to be included. They are:
Acquisitions (including leases or rentals)
Risk assessment and management
Total count of assets
The value of each asset
Details of acquired assets
The expected life cycles of the assets
Banks can easily implement a robust risk management plan for future safety by accessing all of them.
A Comprehensive Approach to ORM
Banks taking a comprehensive approach toward building an ORM (operational risk management) framework can bolster business growth rapidly. The first step to creating a productive ORM capability is to access the existing risk potential in banks. This would help banks create a base out of all internal and external risk events. Then, to deal with the different types of risks, the development of key risk indicators (KRI) will serve as early warning signals to potential risks. Once the banks successfully identify it, they can decide on mitigation options.
Next, the question arises, how can financial businesses and institutions establish a robust ORM for risk management in the banking sector? The key to establishing an effective ORM is training employees to anticipate future risks, especially during the launch of products, changes in customer interface, outsourcing services, or shifting the core of a business module.
As banks and other financial institutions have embraced agile work modes, ORM experts have become an integral part of the operation. Like, JPMorgan Chase, ORM lies at the heart of all its processes. It is where the bank develops and tests new business offerings and practices to check the potential risks in the following. In addition, other U.S. banks have built a dedicated cyber-risk team that simulates attacks and takes action to prevent potential operational risks.
However, identifying and alleviating operational risk is a significant and crucial task that needs to be left only to the ORM experts.
A Move Forward with the Operational Risk Management Framework
The components of risk management in banks
examined above have proved beneficial for the operational risk management function.
Operational risk management in the banking sector should ensure that an institution's operational risk framework is reliably implemented and performs well. The institution should ensure that the framework provides thorough coverage across the various operational risk event types and conduct ongoing support for individual components and the overall operational risk framework.
Businesses and financial institutions should leverage the operational risk management framework
as part of a broader effort to improve sustainability, including estimation of forecasting efforts. Therefore, the operational-risk discipline can create a more secure and profitable institution in the future.
"The art of banking is always to balance the risk to run with the reward of a profit”
Jamie Dimon, chairman and CEO of JPMorgan Chase
Frequently Asked Question
What are the most prominent operational risks in banks?
Process risk, systems risk, external event risk, and legal and compliance risks are the significant operational risks in banks.
What is the primary function of operational risk management?
The primary function of operational risk management is to reduce risks through risk identification, measurement and mitigation, risk assessment, monitoring and reporting.
How to identify operational risks in banks?
Banks must assess and manage operational risk using various tools and strategies. Banks identify potential operational risks in the following ways:
Business disruptions and systems failures
Accounting or data entry errors
Inaccurate client records