Chapter 6: A Predictive Model for E-Bank Operational Risk Management

6.1 INTRODUCTION

The term "operational risk" in the financial industry was probably used for the first time in 1995. This was as a result of the infamous bankruptcy of Barings Bank in which a trader brought down the venerable bank by hiding futures and derivatives positions in the Asian markets. This event raised the awareness of financial institutions to this risk type, which could not be classified as either credit or market risk and which until then had not been properly appreciated, despite the considerable impact that it might have on results. As a result, from 1995 until today there has been a rapidly growing recognition of the importance of operational risk in banks. ^[*] A survey conducted by the British Bankers Association in 2000 showed that banks estimated that their risks are divided into credit (60%), market and liquidity (15%), and operational risk (25%). This is an approximation, as no financial institution has yet derived a credible and reliable measure for its global operational risks. It is important to highlight that at the time of the Barings event, banks did not acknowledge this risk category explicitly, with the result that they have belatedly come to recognize these risks in their risk management framework/processes.

In terms of a formal definition, operational risk has been defined by the Basel Committee as the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events; operational risk, therefore, is related...