OPERATIONAL RISKMANAGEMENT

experience in building a Basle II compliant ORM software ORBIT

Hightening Operations RiskHighly Automated Technology - if not properly controlled has the potential to transform risks from manual processing errors to system failure risks.Networked computers ATMs EDCs providing seamless movement of fundsRTGS and cross country fund transfersWeb based account operations Idbi bankBranch CBranch ABranch BBranch XATM RATM RATM RATM RATM RATM RShared ATMEDC at POS

Emergence of e-commerce - risks not fully understood.E Seller ALogistics CompanyE BuyerClearing AgencyBank X Bank M Hacker

Mergers, de-mergers and consolidation -test the viability of newly integrated systems.Bank ABCFinacleK+ITMSBank XYZBank MasterIRISCITI SolThe Merged BankHow to integrate systemsMigrate DataCreate new controls

Emergence of banks acting as very large-volume service providers - needs maintenance of high-grade internal controls and back-up systems.Electronic collection of Telecom Bills for a client base of 1 million bill collection every month. 12 million transactions annuallyDividend Payment mandate for Reliance 3.5 million share holders Instant credit of amount promised

Outsourcing arrangements - may present significant other risks.Call centres: to respond to customer clients Have a chat with your credit card care agencyClearing Upload and checking by contract agencyCollection of cash/cheques from clients premises through security agenciesCourier services for delivery of cards/PINs and statements

Developing an Appropriate Risk Management StructureBoard of DirectorsInternal AuditorsSenior MgtRisk Management CommitteeRisk MgtOperations Personnel and Risk Takers

The Committee has proposed that the Minimum Regulatory Capital (MRC) be lowered from 20% of minimum regulatory capital of 8% (i.e. 1.8% of the total risk weighted assets) to 12% (ie 1.08% of the total risk weighted assets).

With AMA implementation this can be brought down to 9% (0.72%). THE KEY DRIVER

idbi bank has adopted Basels definition of Operational Risk ..

The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. DefinitionExternal Events

BASLE II has prescribed Three approaches :

Basic Approach Standardised ApproachAdvanced Management Approach - AMA

Idbi bank has chosen to go by the AMA

BASIC INDICATOR APPROACH Banks using Basic Indicator Approach(BIA) have to hold capital for operational Risk equal to a fixed percentage (alpha) of a single indicator (Gross Income) K = EI * Where K = Capital charge under BIAEI = Gross Income = a fixed percentage set by the Basle committee (LDCEs are conducted for this purpose.)

STANDARDISED APPROACHBanks activities are divided into 8 Business Lines. Each Business Line is measured by an Exposure Indicator which is Gross Income for that Business Line. Within each Business Line the capital charge is calculated by multiplying the said Business line Gross Income by a beta factorThe sum of all Business Line Capital charge would be the Capital charge for the Bank.

K = E (EI * )

K is capital chargeEI is Exposure Indicator Gross Income is the a fixed percentage for each Business line set by the Basle Committee.

ADVANCED MEASUREMENT APPROACH (AMA)The AMA gives banks incentive to collect internal loss data step by step. Under the AMA banks would be allowed to use the capital charge as per their internal measurement systems subject to Qualitative & Quantitative standards set by the Committee.

Among the most important of these quantitative standards is that the risk measurement system must be based on internal loss data that can be mapped into the Basle Committees specified Business Lines and Loss Event Types.

Organisation Structure

Bank has developed a framework called ORBIT (Operational Risk Business Intelligence Tool) for measuring, monitoring and controlling Operational Risk, based on the guidelines set by Basel.

The main features of the framework of Operational Risk developed by IDBI Bank are as under:

KRI data gathering frameworkControl FrameworkIncident Reporting Structure (IRS) data gathering frameworkVaR EngineQuery and reporting Scenario analysis

Framework

Key Risk Indicators (KRIs) are identified product wise.

Each KRI is linked to a product and each product to a Business line.

Business lines are defined as per Basel guidelines.

For any new product introduced by the Bank , KRIs are identified and gathered. KRI - Data Gathering Framework

KRI - Data Gathering Framework(KRIs) framework pinpoints information from Core banking software for use in ORBITMost of the KRIs are gathered using an automated data upload process by which specific KRI are sourced from various applications of the Bank viz. Finacle, Net Bkg, Phone bkg, ATM etc.. Additionally, there are some KRIs which are sourced by means of manual feeds from branches / various functions. KRIs are gathered every month and stored in the KRI data base from which Analysis of Ops data is done kri

comprises of :

Branch operations performance ratingTrigger reports moduleControl Framework

KRIs are rated on a five grade scale: Excellent / Good / Satisfactory / Fair / PoorRatings are done by attributing weights to certain critical KRIs.Rating parameters are classified into five categories & Weight assigned to each category . People management Business management Security management Customer management Compliance with internal policyOperational quality of a branch is rated on a 5 grade scale: Well managed / Low risk / Medium risk / High Risk / very High Risk. Model Control Framework - Branch Performance Rating

This module consists of reports, which as the name suggests, are triggered whenever certain events occur viz.

Brisk Triggers. A trigger report is generated for branches which have scored poor in any of the parameters used in Ops rating model for branch heads to take corrective action.

Report also goes to controlling authority concerned for monitoring corrective action effectively.

Control Framework - Trigger Reports

An operational loss event is defined as one where the Bank suffers either an actual loss or a potential loss.

Under the Advanced Measurement Approach, historical loss data forms the basis of VaR. The loss data is captured using an incident report framework. IRS is a loss incident gathering framework. An incident report is filed on the occurrence of an operational loss event. Loss event is categorised by Loss event category and Business line.

Event IRS Structure

VaR Model facilitates computation of Economic Capital for Operational Risk.

Idbi bank has classified its business lines. Loss event category and loss effect category as per the guidelines of BASEL.

Under this approach idbi bank estimates the likely distribution of operational loss over one year horizon, for each business line and loss event type, at a confidence level of 99.9%.

VaR Engine

VaR Engine Methodology

Methodology for VaR Computation-

Data collection capturing of Loss Data.

Curve Fitting applying Statistical formulas on Loss Data.

Simulation applying Monte Carlo Simulation

VaR Estimation reading the final value using a 99.9% Confidence Level.

Perform the same iterations for each Business Line, Event type combinationVaR Estimate for the Bank is the sum of all VaR estimates for all the Business Lines of the Bank.

ReportsQuery & Reporting

This module generates queries/reports branch-wise, region wise and product wise.

Scenario Analysis

What if analysis adds flexibility to the system to stimulate the impact of external loss/fraud event or any extreme values.

Challenges for Indian banks

Data availability & integrityData warehousing / miningBuilding up processesStrengthening skills Model validation requires greater collaboration with regulatorCost - investment in risk analytics and risk technology getting management buy-inStress testing, scenario analysis building capabilities

Thank you!