New frontiers have created new and important risks that can lead to severe losses.
The Need for Risk Management
The international banking system has experienced significant structural changes over the last thirty years. Major banks have merged, many institutions have become global and alliances with insurance companies and other financial service partners are increasingly common. Over the same period, the use of financial engineering and technology has been rising in popularity allowing banks to offer new products and enter into new business activities to satisfy customer needs. The changing structure combined with increased product offerings has been increasing risk exposures for the banking industry that have not traditionally existed particularly in the operational areas.
Operational Risk
There are sophisticated models developed to quantify and hedge market and credit risk, however, operational risk has been a newer occurrence and concern for the industry. These usually include day to day errors that have traditionally been viewed as a fixed cost of operating and were too small to have an impact on the business. The complexity of products is creating an increased likelihood of errors in business operations which can contribute significantly to the risk profile when viewed in aggregation.
Examples of Transaction Risks:
- Mark to model error
- Execution error
- Booking error
- Settlement error
- Volume risk
- Exceeding limits
- Information Risk
Conclusion
The banking industry has been facing changes in organizational structure and expanding product lines leading to new risk exposures that are difficult to quantify since they have not existed in the past. However, failure to identify or neutralize risks in a timely manner can lead to severe financial losses or interruptions in activities that actually add value to corporate goals. A thorough risk management methodology that is regularly reviewed must be implemented to ensure operational stability and organizational health so that further growth can be sustained.