An Environment in Control vs. A Controlled Environment

Alan Greenspan, Chairman of the Federal Reserve American Bankers Association, during Annual Convention on October 5, 2004 held, “It would be a mistake to conclude that the only way to succeed in banking is through ever-greater size and diversity. Indeed, better risk management may be the only truly necessary element of success in banking.”

Financial institutions across the globe are going through a major shift and face an environment marked by extreme volatility, uncertainty, high customer expectations, increasing regulatory mandates, extensive financial engineering, increasing use of technology and related innovations, and competition. The probability of failures or mistakes has never been higher from operations points of view, thus necessitating an increased focus on managing operational risks.

Establishing metrics for the operational risk management have always been a challenge. This challenge has been further complicated by the compliance regulations like Basel II and SOX, that mandate a focus on managing operational risks, forcing financial institutions to identify, measure, evaluate, control, and manage this risk. This has made Operational risk management one of the most complex, fastest growing, and very demanding disciplines across most financial institutions.

There has been a growing acknowledgement across financial institutions that a consistent and effective operational risk management framework can help them achieve better performance and overall organizational objectives. For example, a well structured and executed operational risk process in the entire value chain, can ensure that risks inherent to each function are identified, put into the right perspective, and eventually properly addressed. In many instances, an early involvement of the operational risk regime can increase the development speed of new initiatives.

The regulations, like Basel II Capital Accord, that requires banks to set aside capital for operational risks has also significantly contributed towards the change in institutional mindset across the globe. Considerable investments have been made by the financial institutions towards risk processes improvements, data infrastructure, and analytical capabilities. While Basel II has certainly contributed towards overall enhancement in operational risk controls, the implementation challenges for operational risk management have also been many. Escalating costs of compliance to regulations and central-bank regulatory requirements in many countries across the world remain a major operational risk challenge.

A “embedded” operational risk framework ensures that business actions and more importantly, the decisions are demonstrably influenced by risk management considerations and risk management information, indicating integration of the framework itself and its alignment with business processes.

Author’s Note. “The views and opinions expressed in this article are strictly those of the author and do not reflect the official policy or position of any company.”

Originally published on LinkedIn, 4 May 2020.