{"id":31126,"date":"2020-04-21T12:29:13","date_gmt":"2020-04-21T06:59:13","guid":{"rendered":"https:\/\/enterslice.com\/learning\/?p=31126"},"modified":"2020-11-23T17:16:17","modified_gmt":"2020-11-23T11:46:17","slug":"managing-operational-risks-in-banking","status":"publish","type":"post","link":"https:\/\/enterslice.com\/learning\/managing-operational-risks-in-banking\/","title":{"rendered":"Managing Operational Risks in Banking"},"content":{"rendered":"<p class=\"has-drop-cap\"><strong>Risk management is a process in which the future risks of a business are identified. Once the risks are identified, the firm develops effective strategies to reduce or curb the risk. If this system is followed, a company can adequately handle the risks that come up<\/strong>. However, for an effective risk management system in place, the risks have to be categorized according to the potential damage caused to the business. By doing this, a proper system of risk management can be streamlined into the operations of a business. <a href=\"https:\/\/enterslice.com\/fraud-risk-management\"><strong><em>Risk Management<\/em><\/strong><\/a> is there in every business and organization. This system of risk management is also present in the Banking and Finance Companies. <strong>Without having an effective risk management system in place, banks and finance firms cannot make business decisions. In the Banking, Finance, and Insurance Sector (BFSI Sector), risk management is crucial for the development of the banking sector<\/strong>. Banks without proper risk management strategies could be prone to corporate governance issues, frauds, mismanagement, loan defaults. <strong>Hence operational Risks in Banking are crucial for the development of the banking sector. This will have a direct impact on the economic growth of the country.<\/strong><\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Operational Risks in Banking &ndash; Risk management Process<\/h2>\n\n\n\n<p><strong>For managing operational risks in banking, it is\ncrucial to implement a proper risk management framework in place. This risk\nmanagement framework would act as a guidance mechanism for the bank.<\/strong> By following this framework, the bank can assess compliance with\nrisk management policies and guidelines. <strong>In\nthe situation that a bank is non-compliant with the risk management strategy,\nthen there can be scope for improvement or <a class=\"glossaryLink\"  aria-describedby=\"tt\"  data-cmtooltip=\"&lt;div class=glossaryItemTitle&gt;Internal Audit&lt;\/div&gt;&lt;div class=glossaryItemBody&gt;A glossary on internal audit is a valuable resource that compiles and defines essential terms and concepts in the field of internal auditing. It aids professionals and learners in comprehending(...)&lt;\/div&gt;\"  href=\"https:\/\/enterslice.com\/learning\/terms\/internal-audit\/\"  data-gt-translate-attributes='[{\"attribute\":\"data-cmtooltip\", \"format\":\"html\"}]'>internal audit<\/a> (screening).<\/strong>\nThrough the internal audit process, a useful framework can be streamlined and\ncomplied. Operational Risks in banking can be effectually managed following the\nabove process.<\/p>\n\n\n\n<p><strong>The procedure required to be followed in Managing Operational Risks in Banking is as follows:<\/strong><\/p>\n\n\n\n<ol><li><strong>Risk Identification Mechanism<\/strong>&ndash; For a bank or financial institution, identifying various risks poses a big challenge. This is challenging because there are many changes in the economy.<strong> Because of constant fluctuations in the <a class=\"glossaryLink\"  aria-describedby=\"tt\"  data-cmtooltip=\"&lt;div class=glossaryItemTitle&gt;Market&lt;\/div&gt;&lt;div class=glossaryItemBody&gt;A market is a structured environment, either physical or virtual, where buyers and sellers convene to trade goods and services. This trading hub operates based on the principles of supply and(...)&lt;\/div&gt;\"  href=\"https:\/\/enterslice.com\/learning\/terms\/market\/\"  data-gt-translate-attributes='[{\"attribute\":\"data-cmtooltip\", \"format\":\"html\"}]'>market<\/a>, these would create significant risks in the banking sector<\/strong>. Apart from this, other challenges bring out various risks. These include- <strong>the development of technology, the use of mobile-based banking applications for carrying out transactions, the development of <a class=\"glossaryLink\"  aria-describedby=\"tt\"  data-cmtooltip=\"&lt;div class=glossaryItemTitle&gt;Artificial Intelligence&lt;\/div&gt;&lt;div class=glossaryItemBody&gt;Artificial Intelligence, often abbreviated as AI, is a transformative technology that has captured the imagination of scientists, engineers, and visionaries for decades. In this comprehensive(...)&lt;\/div&gt;\"  href=\"https:\/\/enterslice.com\/learning\/terms\/artificial-intelligence\/\"  data-gt-translate-attributes='[{\"attribute\":\"data-cmtooltip\", \"format\":\"html\"}]'>Artificial Intelligence<\/a> (AI), IoT (Internet of things), and machine learning processes would increase the operational problems in the bank.<\/strong>&nbsp; However, going by this, the<strong> management of banks should be more vigilant and adjust to the development of technologies<\/strong>. By carrying out the above processes, the bank can effectively manage operational risks in Banking.<\/li><\/ol>\n\n\n\n<p>However, the\ndevelopment of various technologies should be considered a benefit to the bank\nrather than a deterrent. With the use of technologies, banks could assess and\npredetermine multiple risks. <strong>For\nexample- by using a loan software that has Artificial Intelligence enabled in\nit, the bank can understand the borrowing behaviour of specific borrowers and predetermine\nwhether to provide the loan or not.<\/strong><\/p>\n\n\n\n<p>Similarly, like loan predictive software, which is used by various banks, other benefits can be availed by a bank using such technologies. Some of them are: <\/p>\n\n\n\n<ul><li>Understanding the market using predictive technologies;<\/li><li>Consumer behaviour analysis;<\/li><li>Technology not only helps the bank in becoming digital but also helps in increasing the amount of vigilance that is used in Banking Software;<\/li><li>It would help them to prioritize their banking and business goals faster thus saving excess time which is used in traditional banking processes; and<\/li><li>Use of these technologies also improves the overall corporate governance framework of the bank.<\/li><\/ul>\n\n\n\n<p>Therefore by using such technologies, operational risks in banking processes can be effectually managed.<\/p>\n\n\n\n<p><strong>2. Risk Analysis and Measurement-<\/strong> <strong>The next step in the risk management process of the bank is to measure the potential impact of the risk.<\/strong> Such can only be carried out by measuring the risk. By considering this option, a bank can understand how much threat is caused by the risk. They can effectively categorize the risk according to the potential danger they pose for the bank. These risks are measured based on the following <a class=\"glossaryLink\"  aria-describedby=\"tt\"  data-cmtooltip=\"&lt;div class=glossaryItemTitle&gt;Basis&lt;\/div&gt;&lt;div class=glossaryItemBody&gt;In finance, the &amp;quot;basis&amp;quot; is a term with several applications, including representing the difference between the spot price and the future contract price of an asset, which is vital in investment(...)&lt;\/div&gt;\"  href=\"https:\/\/enterslice.com\/learning\/terms\/basis\/\"  data-gt-translate-attributes='[{\"attribute\":\"data-cmtooltip\", \"format\":\"html\"}]'>basis<\/a>:<\/p>\n\n\n\n<ul><li><strong>High-level Risks<\/strong><ul><li>Market Risks<\/li><li>Lending Risks<\/li><li>Corporate Governance<\/li><li>Transparency<\/li><li>Frauds<\/li><\/ul><\/li><\/ul>\n\n\n\n<ul><li><strong>Low- Level Risks<\/strong><ul><li>Changes in technology<\/li><li>Development of banking software on smartphones<\/li><li>Customer Satisfaction<\/li><\/ul><\/li><\/ul>\n\n\n\n<p>The risks have\nto be measured and classified according to the potential threat they post.&nbsp; <strong>Market-related\nrisks can be dependent on various factors such as a change in GDP, amount of\nloans taken, consumer behaviour, changes in regulation.<\/strong> All the market\nrisks can be classified as high-level risks. Classifying this as a higher risk\ncategory will help in managing operational risks in banking. The other form of\nrisk also poses potential issues to the bank. <\/p>\n\n\n\n<p><strong>Corporate governance can be understood as having a proper framework and transparency between the shareholders, directors, and stakeholders.<\/strong> By ensuring that this framework is achieved in the bank, the amount of operational risks in banking can be handled. There has to be adequate transparency between the management and the public. <strong>Stakeholders are the primary sources of business of a bank. Hence a practical framework related to corporate governance is required for managing operational risks in the banking sector.<\/strong><\/p>\n\n\n\n<p><strong>Lending Risks are the main issues what is faced by\nbanks.<\/strong> Banks are hesitant to provide loans without\nproper security. On the other hand, there are excessive lending practices that\nare practiced by particular banks. Exorbitant interest rates are also charged\non loans. Lending risks are one of the main priorities of a banking risk as the\nbusiness of banking depends on lending. <strong>The\nApex authority can monitor aggressive lending practices. Such a central body\nthat regulates the banking sector in India is the Reserve Bank of India (RBI).\nThe RBI has brought out specific mechanisms for handling the risks. <\/strong>&nbsp;This was brought out in <strong>2002, as the Guidance Note on Managing Operational Risks in a Banking\nSector.<\/strong> The guidance note stressed on specific areas where operational\nrisks in banking occur. Apart from the need of having senior management and\nboard, they emphasized on the following:<\/p>\n\n\n\n<ul><li>Automation Processes Risks;<\/li><li>E-Commerce and other technologies risk;<\/li><li>Outsourcing Activities which are carried out by the financial sector;\nand<\/li><li>Acquisitions by banks.<\/li><\/ul>\n\n\n\n<p>While considering\nthe factors, which create a threat to the bank, all the above factors have to\nbe accessed and analyzed. If this is followed, then operational risks in the\nbanking sector can be handled.<\/p>\n\n\n\n<p>When it comes to\n<strong>handling low-level risks, though these\nrisks are lower in the damage that can occur due to the risk, they still pose a\npotential risk to the banking processes.<\/strong> By dividing the above risks as\nhigh-level risk and low-level risks, the bank can prioritize the amount of time\nrequired to develop a proper strategy to effectively handle the risks.<\/p>\n\n\n\n<p><strong>Changes in technology have been a risk ever since 2010<\/strong>. <strong>With the advancement of\ndigitization and the development of the tech bubble, start-ups have been\nproductively collaborating with banks and financial institutions to develop\nproducts. <\/strong>One of the main risks posed by banks here is the reluctance of a\nbank to use the technologies that are produced by start-ups. <strong>However, from the front of a Non- Banking\nFinancial Company (<a class=\"glossaryLink\"  aria-describedby=\"tt\"  data-cmtooltip=\"&lt;div class=glossaryItemTitle&gt;NBFC&lt;\/div&gt;&lt;div class=glossaryItemBody&gt;Non-Banking Financial Companies (NBFC) operate similarly to banks but do not possess the legal status of a bank. Registered under the Companies Act 2013 and governed by the RBI Act&amp;#039;s section(...)&lt;\/div&gt;\"  href=\"https:\/\/enterslice.com\/learning\/terms\/nbfc\/\"  data-gt-translate-attributes='[{\"attribute\":\"data-cmtooltip\", \"format\":\"html\"}]'>NBFC<\/a>\/ NBFCs), these technologies are adopted. <\/strong>These make\nthe NBFCs more competitive to banks. Therefore for a framework to operate\nsuccessfully, the bank has to make way to adopt new technologies. This would\nhelp in reducing the operational risks which are posed in the banking sector.<\/p>\n\n\n\n<p>With the <strong>development of software&rsquo;s on smart phones,\nbanks have to tackle new risks<\/strong>. <strong>Some\nof these risks involve spreading awareness to existing banking customers\nregarding the use of the mobile-based application. This would be a challenging\ntask for a bank, considering the population of India. Another risk that is\nprone to the advancement of software is the increase in the number of frauds\nthat take place in a bank.<\/strong> <strong>These\nfrauds can be divided into internal scams, external frauds, and third party\nfrauds<\/strong>. All these frauds pose a significant threat and would pose as potential\noperational risks in banking. <strong>To tackle\nsuch operational risks in banking, there is the requirement of streamlining a\nproper system of firewalls; virus protection software&rsquo;s in the application.\nThis would significantly reduce the amount of operational risks in banking\nprocesses.<\/strong><\/p>\n\n\n\n<p>Therefore by\neffectually measuring the risks based on the potential damage caused, the bank\ncan classify and categorize the risks and spend more time developing ideas to\ntackle these risks.<\/p>\n\n\n\n<p><strong>3. Development of Solutions-<\/strong> <strong>Once risks are identified and measured on the potential impact, solutions are developed to reduce or eradicate the risk.<\/strong> While certain risks are unavoidable, the effective way to handle them is to ensure that the damage caused by the risk is less. <strong>For example- consider the market-related risks in a bank. Developing effective risk mechanisms in place can reduce the amount of damage caused by the market risks. It cannot eliminate the risks that are formed due to the factors which affect market strategy.<\/strong><\/p>\n\n\n\n<p>Similarly, <strong>if there is a technological problem that poses as a risk in a bank, it\ncan be solved by having proper support in technical processes<\/strong>.&nbsp; By considering various solutions in the risk\nmanagement process, the management can effectively reduce operational risks in\nbanking. <strong>If there are risks related to\nfraud, then there has to be useful systems in place to reduce the number of\nfrauds that occur in the banking process.<\/strong><\/p>\n\n\n\n<p><strong>4. Implementation- <\/strong>Implementation is crucial for managing operational risks in banking. After solutions are developed, to understand the risks which affect the bank, effective implementation mechanisms are required. <strong>Without effective implementation and auditing, there will be no scope for improvement. Once a solution is implemented in the banking process, there can be space for understanding existing flaws in the solutions. <\/strong>Solutions can be effectively implemented after this process. <\/p>\n\n\n\n<div class=\"shadow1\"><strong>For\nexample- for understanding the loan lending patterns and repayment patterns by\nconsumers of a bank, many banks use predictive analysis software for\nunderstanding the repayment pattern.<\/strong> The use of <strong>AI and predictive analysis is a solution\nfor banks for securing information on repayment. <\/strong>Through effective\nimplementation, the operational risks in banking can be significantly reduced. <strong>However, operational risks in banking can\nbe managed not only through the process of practical implementation. &nbsp;They have to be screened and audited\nregularly. <\/strong><\/div>\n\n\n\n<p><strong>5. Proper Monitoring-<\/strong> <strong>Monitoring processes helps reduce operational risks in the banking processes. Having a monitoring agency is required.<\/strong> This would ensure that the bank works according to the standards prescribed by the monitoring agency. <strong>Apart from this, the monitoring agency has the power to amend various rules from time to time. These rules have to be effectively followed by banks to reduce the operational risks in banking.<\/strong> Monitoring processes can be done through internal and external means. Internally the banks can be monitored by having executives who are independent in policy and decision making. Through internal monitoring policies, banks can achieve transparency. According <strong>to the Banking Regulation Act, 1949, banking companies are required to have independence at a senior level. <\/strong>This would ensure that proper corporate governance is maintained throughout the bank. <\/p>\n\n\n\n<p><strong>External monitoring processes can be conducted by an\nindependent consultant performing the features such as the internal audit\nprocess for the bank.<\/strong> <strong>By using external audit processes in banking, the banks can ensure that\nthere is independence as the relationship maintained by the external consultant\nwould be related to the beneficiary and fiduciary<\/strong>. Professionalism will be\npreserved if this relationship subsists in the banking process.<\/p>\n\n\n\n<p>Monitoring does\nnot stop just by having an internal process or an external process.&nbsp; Assessing the actual standards which are\nrequired to be provided by the banking industry to the current standards\nprovided by the bank has to be measured. <strong>This\nis also known as the process of Quality Assessment. Quality Assessment\npractices are used by various banks to understand the practices followed by a\nbank. These practices are compared to the national or internationally accepted\nstandards, which are followed by a banking system. One such quality assessment process\nis called a Collection Process Assessment.&nbsp;\n<\/strong><\/p>\n\n\n\n<p><strong>Collection Process Assessment is a procedure in which\nthe actual standards of loan collection processes which are used by bank is\ncompared to the standards which are determined by a central banking authority.<\/strong> By comparing the standards of loan collection processes with the\nactual standards, the bank can implement changes in the flaws of the loan\ncollection processes. <strong>Using such systems\nin place will ensure that operational risks in a bank are reduced.<\/strong><\/p>\n\n\n\n<p>Therefore\nthrough proper channels of monitoring, operational risks in banking can be\nreduced. However, having a system to access the monitoring standards of the\nbank will ensure to improve the efficiency of the bank.<\/p>\n\n\n\n<p>If a bank\nfollows the following steps, it can ensure to reduce the amount of risks. However,\nthese steps have to be implemented throughout the banking systems. <strong>This will ensure that there is transparency\nwithin all processes in a banking system.<\/strong><\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Collapse of IL&amp;FS- NBFC- Faulty Operational Risks in Banking<\/h2>\n\n\n\n<p><strong>The Collapse of IL&amp;FS (Infrastructure Leasing\n&amp; Finance Services) was a shocking revelation to investors and stakeholders\nof IL&amp;FS.<\/strong> Through proper risk analysis reports,\nit would found out that the directors of the committee had sanctioned various\nloans to borrowers. <strong>The internal risk\nmechanisms reported that the borrowers who had taken loans from IL&amp;FS were\nnot able to repay them. <\/strong>This is one of the High Level Risks, which was not\nconsidered by the financial institution. <strong>The\nloans which were sanctioned were based on the negative spread. The negative\nspread is viewed as a mechanism where the interest rates on the loans borrowed are\nlesser than the interest rates of the loans when paid.<\/strong><\/p>\n\n\n\n<p>The fall of this\nfinancial institution was also supported by a <strong>lack of transparent practices followed by the directors.<\/strong> They did\nnot consider various factors before sanctioning loans. Most of the loans which\nwere sanctioned were provided to borrowers who were under financial crisis.\nFrom the above case, it can be understood that there was no system of managing\nthe operational risks in banking. <strong>Though\nIL&amp;FS is an NBFC, still the operations of the NBFC would be similar to that\nof a banking process.<\/strong> Therefore by following the framework for risk\nmanagement processes, banks can reduce the potential problems which are created\nas a result of the risk.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Conclusion for Managing Operational Risks in Banking<\/h3>\n\n\n\n<p>Before the development of technology and the increase in the number of risks posed to banks, there were no systems in place to monitor the operational framework of banking risks. <strong>With the development of regulation, technology, consumer preference, and markets, the management of banks has to ensure that there are effective mechanisms in place to manage the operational risks in banking.<\/strong> This can be achieved by following the <strong><a href=\"https:\/\/enterslice.com\/risk-and-assurance-advisory-service\"><em>procedure for risk management<\/em><\/a><\/strong>. Banks can understand the nature of the risk and the potential impact of the risk. Based on this, the risks can be divided. Finding effective solutions and implementation of the solutions is crucial in managing operational risks in the banking process. <strong>Through the above procedure, operational risks in banking can be reduced. <\/strong><\/p>\n\n\n\n<div class=\"read\"><p><b>Also, Read:<\/b> <mark><a href=\"https:\/\/enterslice.com\/learning\/risk-assessment-model\/\" target=\"_blank\" rel=\"noopener noreferrer\">What is a Risk Assessment Model<\/a><\/mark>.<\/p><\/div>\n","protected":false},"excerpt":{"rendered":"<p>Risk management is a process in which the future risks of a business are identified. Once the risks are identified, the firm develops effective strategies to reduce or curb the risk. If this system is followed, a company can adequately handle the risks that come up. However, for an effective risk management system in place, [&hellip;]<\/p>\n","protected":false},"author":37,"featured_media":31131,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":[],"categories":[11,1329],"tags":[2931],"acf":{"service_id":"215"},"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v14.6.1 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>Managing Operational Risks in Banking - Enterslice<\/title>\n<meta name=\"description\" content=\"Operational Risks in Banking are crucial for the development of the banking sector. 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This will have a direct impact on the economic growth of the country.\ufeff\" \/>\n<meta property=\"og:url\" content=\"https:\/\/enterslice.com\/learning\/managing-operational-risks-in-banking\/\" \/>\n<meta property=\"og:site_name\" content=\"Enterslice\" \/>\n<meta property=\"article:publisher\" content=\"https:\/\/www.facebook.com\/enterslice\" \/>\n<meta property=\"article:published_time\" content=\"2020-04-21T06:59:13+00:00\" \/>\n<meta property=\"article:modified_time\" content=\"2020-11-23T11:46:17+00:00\" \/>\n<meta property=\"og:image\" content=\"https:\/\/enterslice.com\/learning\/wp-content\/uploads\/2020\/04\/Managing-Operational-Risks-in-Banking.jpg\" \/>\n\t<meta property=\"og:image:width\" content=\"670\" \/>\n\t<meta property=\"og:image:height\" content=\"352\" \/>\n<meta name=\"twitter:card\" content=\"summary\" \/>\n<meta name=\"twitter:creator\" content=\"@enterslice\" \/>\n<meta name=\"twitter:site\" content=\"@enterslice\" \/>\n<!-- \/ Yoast SEO plugin. -->","authorName":"Varun Hariharan","authorImageUrl":"https:\/\/enterslice.com\/learning\/wp-content\/uploads\/2020\/03\/Image.png","authorDescription":"Varun Hariharan has completed the Legal Practice Course from BPP Law School, Manchester. He has a Masters in Commercial and Corporate Law from the Queen Mary University of London and LLB Honours from Bangor University, UK.  He specialises in law related to corporate, artificial intelligence and technology law.","postViews":569,"readingTime":9,"nextPost":{"id":31107,"slug":"an-overall-concept-of-input-service-distributor-isd-under-gst"},"prevPost":{"id":31099,"slug":"msme-samadhaan-to-recover-pending-dues-from-customers-by-msmes"},"featuredMediaUrl":"https:\/\/enterslice.com\/learning\/wp-content\/uploads\/2020\/04\/Managing-Operational-Risks-in-Banking.jpg","postTerms":"CFO Service","_links":{"self":[{"href":"https:\/\/enterslice.com\/learning\/wp-json\/wp\/v2\/posts\/31126"}],"collection":[{"href":"https:\/\/enterslice.com\/learning\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/enterslice.com\/learning\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/enterslice.com\/learning\/wp-json\/wp\/v2\/users\/37"}],"replies":[{"embeddable":true,"href":"https:\/\/enterslice.com\/learning\/wp-json\/wp\/v2\/comments?post=31126"}],"version-history":[{"count":0,"href":"https:\/\/enterslice.com\/learning\/wp-json\/wp\/v2\/posts\/31126\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/enterslice.com\/learning\/wp-json\/wp\/v2\/media\/31131"}],"wp:attachment":[{"href":"https:\/\/enterslice.com\/learning\/wp-json\/wp\/v2\/media?parent=31126"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/enterslice.com\/learning\/wp-json\/wp\/v2\/categories?post=31126"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/enterslice.com\/learning\/wp-json\/wp\/v2\/tags?post=31126"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}