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TRANSACTION – BASED CROSS – ENTERPRISE RISK MANAGEMENT


INTRODUCTION AND BACKGROUND

• The Bank for International Settlements (BIS) established the Basel Committee on Banking Supervision (BCBS) in 1974, in the aftermath of serious disturbances in international currency and banking markets and deterioration in capital ratios.

The Bank for International Settlements (BIS) isan intergovernmental organization of central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks." : Wikipedia

• In 2004, a more demanding Basel Capital Accord (“Basel II”) was introduced with three pillars: Pillar One (capital calculation), Pillar Two (regulatory oversight), and Pillar Three (market disclosure). Also new with Basel II is therequirement for operational risk management

• Basel II classifies operational loss events as resulting from: internal fraud, external fraud, employment practices and workplace safety, clients/products/business practices, damage to physical assets, business interruption and systems failures, and execution/delivery/process management.

• The 2008 financial crisis can be linked to suchexponential risk exposures such as exceptional and unplanned accumulations of risk exposures that escaped the exercising of business judgment simply because executive management was unaware of their existence on such a scale.

• Such risk concentrations are not attributable to any particular category of risk. The unreported risk concentrations that contributed to the current financial crisis were acocktail of all the principal categories of risk—credit market, liquidity, and operational.


• The industry has not yet found a way of identifying a financial institution’s total portfolio of operational exposures in live operating environments and how to put a consistent and comparable value on them.

• Operational risk exposures fluctuate on a daily basis, often dramatically, as aconsequence of changes in transaction volumes, implementations of new technology, failures of existing technology, business reorganizations, staff absences, new products . . . the list is endless.

• Historical loss experience is a useful tool to help focus on current exposure but without the ability to measure current exposure we cannot be proactive in risk management or risk mitigation.



BASELII AND US IMPLEMENTATION


• Unfortunately, It has not yet achieved a meaningful calibration of operational risk capital.

• It has not yet defined the fundamental nature of the measurement unit (or units) of operational risk. We have for all practical purposes deliberately postponed its measurement by defining it in terms of a “qualitative” assessment process rather than a “quantitative”measurement process.

• What stands in the way of incorporating risk measures into this management reporting structure is:

1) Lack of any measure of operational risk exposure.
2) Failure to incorporate the importance of data into risk measurement models and, finally;
3) The lack of any cohesive mechanism to correlate operational risk exposure to historical operational losses.• A first step to calculating a risk based operational capital charge calls for understanding the causal events, We have, unfortunately, failed to develop effective risk metrics in our rush to satisfy the regulators’ well-intentioned interest in calculating operational risk capital protection against unexpected future losses and is commonly referred to as the enterprise value at risk (VaR) at aspecific confidence level over a particular time horizon

• Economic capital is based on a probabilistic assessment of potential future losses and is therefore a potentially more forward-looking measure of capital adequacy than traditional accounting measures. Expressed as the monetary value of capital necessary to adequately support specific risks assumed.

• A robust calculation of...