Mumbai, Oct. 15: The Reserve Bank of India today asked commercial banks to put in place a framework that would ensure management of operational risk as an independent function within the organisation.
The central bank directive comes in the wake of Basel II guidelines that require banks to explicitly earmark capital towards operational risk from April 2007.
While demarcating banks’ activities into eight business lines, the central bank has put the onus on a bank’s board of directors and its senior management to ensure effective management of operational risk.
According to the Basel committee on banking supervision, operational risk has been defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or external events.
There are various types of operational risks. These include internal fraud (employee theft, insider trading), external fraud (robbery, forgery, computer hacking), damage to physical assets (earthquakes, fires), business disruption and system failures.
The central bank today said banks should take various initiatives in developing a comprehensive framework for treating such a risk under the new regime.
RBI has suggested the formation of a detailed organisational set-up consisting of six tiers apart from the board itself.
“The board of directors should be aware of the major aspects of the bank’s operational risks and it should approve an appropriate operational risk management framework for the bank and review it periodically,” the central bank said. The bank’s board should also establish clear lines of management responsibility, accountability and reporting, it added.
Apart from the board, the senior management, according to the central bank, will have a vital task to perform. They should have the responsibility for implementing the framework approved by the directors and this model should be implemented throughout the organisation with staff at all levels being clearly told about their responsibilities.
As regards identification of operational risk, banks have been told to assess such a risk in all material products, activities and systems.
They have also been told that before new products, activities, processes and systems are introduced, the operational risk inherent in them should be identified clearly and subject to adequate assessment procedures.
Though there is no single way to measure operational risk, RBI said banks may develop risk assessment techniques that are appropriate to the size and complexities of their portfolio, their resources and data availability.
Apart from monitoring the events that lead to operational loss, banks have been told to identify appropriate indicators that provide early warning of an increased risk of future losses.