Operational risk information system: a challenge for the banking sector
| DOI | https://doi.org/10.1108/13581980610711153 |
| Pages | 383-401 |
| Date | 01 October 2006 |
| Published date | 01 October 2006 |
| Author | Francisco Flores,Enrique Bónson‐Ponte,Tomás Escobar‐Rodríguez |
| Subject Matter | Accounting & finance |
FEATURE ARTICLE
Operational risk information
system: a challenge for the
banking sector
Francisco Flores, Enrique Bo
´nson-Ponte and
Toma
´s Escobar-Rodrı
´guez
Facultad de Ciencias Empresariales, Universidad de Huelva, Huelva, Spain
Abstract
Purpose – The purpose of this paper is to analyse the capacity of response of the banking sector’s
information systems (IS), in the light of the new requirements of Basel II (Basel Bank for International
Settlements) on the measurement and control of operational risk (OR).
Design/methodology/approach – By means of a structured case, developed with a Spanish
savings bank of medium size, an analysis is made of the practices and structures that may need to be
modified to prevent a loss of competitive position. Lastly specific improvements are proposed to
facilitate the implementation of an operational risk information system (OR-IS).
Findings – The paper concludes that there still exists a considerable distance between the current IS
in use and an OR-IS compatible with the model proposed under Basel II, for that kind of entities, and
indicates the opportunities and incentives that would arise in the attempt to reduce this distance.
Practical implications – The IS of a bank should evolve towards the achievement of an OR-IS that
enables the bank’s competitive position to be strengthened. In addition, the bank should aspire to
obtain the external validation of its supervisory authority, which certifies the OR-IS implemented and
classifies it as an advanced measurement approach (AMA) under Basel II. An analysis is made of the
principal organisational weaknesses and necessities that should be rectified, with a view to applying
the methodologies designated the AMA to OR in the Basel II agreement.
Originality/value – Basel II has given increased visibility to the “OR” variable and there has been
little explicit research into the process by which managers and organisations at medium sized entities
decide to develop IS capable to measure and mitigate this new risk.
Keywords Banks, Informationsystems, Financial risk, Spain
Paper type Research paper
1. Introduction
The information systems (IS) of the international banking sector face a major
challenge, after the imminent entry into force of the new Basel capital framework
(Basel II), expected for the period 2006-2008. This agreement establishes the need to
manage operational risk (OR) as a fundamental variable for ensuring the survival and
the competitive position of the banking organisation.
There has been little explicit research into the process by which managers and
organisations decide to develop IS applications (Boonstra, 2003). This study covers a
need for previous analysis required by strategic decision-making in the banking sector.
It is a phase in which the strategic decisions in respect of investment in IS should be
taken in consideration of the essential role that these systems play in support of the
organisation’s core-competences (Duhan et al., 2001), principally in entities based on
the application of specialist knowledge, such as those of the banking sector. Nonaka
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Operational risk
information
system
383
Journal of Financial Regulation and
Compliance
Vol. 14 No. 4, 2006
pp. 383-401
qEmerald Group Publishing Limited
1358-1988
DOI 10.1108/13581980610711153
and Takeuchi (1995) state that it is important for any entity to have the capacity for
creating knowledge. The Basel II agreement exhorts banking entities to be creative in
the design and configuration of their own particular operational risk information
system (OR-IS), using the most advanced methods of OR management; the agreement
only stipulates requirements of a general character.
Basel II has given increased visibility to the “OR” variable, whose management is
directly linked with the structure and hierarchy of the organisation, to physical and
computer systems security, to inter-organisation and labour relationships, and generally
to the management of assets, execution times and work activities. This focusing on OR
has had a tremendous impact on the banking sector (Chapelle et al., 2004).
According to Basel II, OR is defined as the risk of loss resulting from inadequate or
failed internal processes, people and systems or from external events. This defin ition
includes legal risk, but excludes strategic and reputation risk. The entity must
determine what is its level of OR and then implement a capital requirement (reserves,
own funds, provisions, ...) that would cover that risk. For each of the types of risk
contemplated in Basel II, the entity must possess and maintain a minimum amount of
capital, by way of reserves and other accounts items. This would enable it to cover the
eventual losses. It is not an overstatement that capital is the key factor in the banking
sector (Rowe et al., 2004), more so perhaps than in the non-financial sector; and only an
adequate IS can manage capital effectively. In fact, if the operational losses are caused
principally by the incorrect functioning of the bank’s IS, the bank can only handle this
risk by a re-configuration of its IS.
In short, what we refer to as the OR-IS is the bank’s IS fully configured to respond to
the challenges represented by the management of OR as defined in Basel Committee
(2005).
By means of an effective OR-IS, the entity would minimise its risks, so as to
minimise the capital charges mentioned. Thus, the entity would release resources,
could take on more debt, and would thus become more competitive.
If the entity (Figure 1) over-estimates its level of OR, the resulting capital charge
would be excessive and limit its capacity for indebtedness, and therefore, harm its
competitive position. If, to the contrary, it under-values its position against this
variable, it runs the danger of its activity collapsing if it does not have sufficient capital
reserves available to cover the losses suffered, due essentially to the malfunctioning of
its IS. This is so important today that capital regulation has now become a major
strategic theme for bank management (Lastra, 2004).
This is the first time that a variable related to the internal structure of the
organisation and its information flows will have an impact on the capacity for
indebtedness of a banking entity (Boixo-Pe
´rez-Holanda and Flores-Mun
˜oz, 2005), and
therefore, on its relative position in the sector. By means of the measurement of OR, the
correct management of the bank’s IS is translated directly to the capacity of the
organisation to hold a better position in the sector, due to the incidence on the own
funds that has been indicated. However, the cost of implementing Basel II is such that
many entities will only apply it to its full extent if the result will be significantly to
improve their competitive situation (Milligan, 2004). Therefore, both academics and
practitioners are interested in clarifying the route to follow for the correct adaptation of
the IS to these special requirements, particularly bearing in mind that the IS could be
efficient custodians of “best practice” (Kazimi, 2005).
JFRC
14,4
384
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