The management of operational risk in South African banks

Abstract

One of the biggest problems South African banks are experiencing when managing operational risk is the lack of a single definition for operational risk. Operational risk can take many forms; for example computer system failure, the malfunction of an ATM or in same instances the long queues at a bank can be an operational risk It is clear that banks lack sufficient information to distinguish between different operational risk events as well as other risk events like credit risk, market risk, etc. In other words, banks are experiencing great difficulties with the identification of operational risk in South Africa. The study therefore aims to determine and construct a single definition of operational risk that will be sufficient for the assessment of operational risk management in South Africa. The study also aims to examine the existing as well as the possible methods to identify, quantify and measure operational risk The main goal of this study is therefore to investigate the feasibility of capital provisions as a way of managing operational risk in South African banks, in other words the viability of the New Basel Capital Accord on South African banks. The methodology used includes a literature review, in-depth interviews and a case study on South African Retail Bank to determine and evaluate some of the most renowned indicators of operational risk in South Africa. The first objective was to determine a single definition of operational risk in South Africa. As mentioned, South African banks are having great difficulties to find a single definition of operational risk and this is causing problems in identifying operational risks in South Africa. It is the view of this study that the Basel Committee's definition is not sufficient enough for operational risk management in South Africa; therefore there is a great need to find a single definition of operational risk in South African banks. The second objective is to provide an overview of the Base1 Committee and its Capital Accord, by focusing on one of the outstanding changes to the existing accord, which is the proposed explicit capital requirement for operational risk. It has been established that the Base1 Capital Accord is widely adopted around the world. Consequently, from the viewpoint of being competitive, it is to the advantage of a bank to adhere to the prescriptions of the Base1 Capital Accord. However, to stay relevant, the Basel Capital Accord was due for a review. The Basel Committee released a proposal to replace the existing Basel Capital Accord with a more. risk sensitive framework. The new framework intends to improve safety and soundness in the financial system by placing more emphasis on banks' own internal control and management, the supervisory review process, and market discipline. The third objective of this research was to present the theory of asset and liability management (ALM) within the unifying theme of operational risk management. It was indicated that capital is used to absorb an operational risk loss. The Asset and Liability Committee (ALCO) is responsible for the strategic management of a bank's balance sheet, therefore also ALM, and as capital forms part of the banks balance sheet, it is also the responsibility of the ALCO to manage the capital that is used as provision for an operational risk. The fourth objective was to determine and evaluate the key risk indicators of operational risk in South Africa theoretically and then also by means of a case study on a South African Retail Bank and then to made some recommendations regarding the effective identification of the key indicators of operational risk in South Africa. It was indicated the challenge in identifying key operational risk indicators is to find indicators that is not only business-specific but are also firm wide indicators of operational risk. Recommendations on the effective identification of key operational risk indicators were made.