Preface

The management of operational risk is one of the broadest functions of any bank or financial institution and one of the hardest to compartmentalise. Over the past two decades, understanding of operational risk has grown rapidly. Alongside this understanding, however, the realisation has emerged that only limited data is available. As a whole, the banking industry often has to deal with operational risk by trial and error. This book continues the discussion of bank operations. It examines how banks deal with operational risk, considers some case studies and lessons from the past and discusses how regulators approach operational risk.

This book is divided into four parts and eleven chapters that delve deeply into the subject matter. Despite the depth, the discussion here is unlikely to be enough to fully grasp the challenges of operational risk that have been high up on the list of considerations for the Basel Committee on Banking Supervision (BCBS) since the late 1990s. Further reading is encouraged and suggestions are provided at the end of each chapter.

Every effort has been made to ensure that policies and regulations discussed in this book are up to date and current. Most regulations on operational risk in use around the world are based on Basel II, which this book discusses at length.

The first part of this book starts with a background discussion of what operational risk is in the banking industry as differentiated from other types of risk commonly addressed such as credit risk, market risk, and operations risk. It also discusses how operational risk considerations in the banking industry may differ from other industries. With a broad definition at hand, this part goes on to discuss operational risk frameworks and best practice principles. The part ends with a series of real life cases that give a practical relief to theoretical discussions of operational risk management.

The second part of this book, which starts in Chapter 4, looks at how banks can and should undertake operational risk planning. The first chapter in this part considers the various methods and tools available to banks and other financial institutions. The second goes on to discuss how best to identify risk, and carry out risk and control self-assessment (RCSA). The final chapter in this part looks at how to measure and assess risk to determine the probable potential loss.

The third part of this book launches in Chapter 7 with an in-depth look of operational risk management. It starts out with considerations of risk control and mitigation followed by Chapter 8, which considers issues of escalation, key risk indicators (KRIs), and risk reporting at some length. This part ends in Chapter 9 with a discussion of associated techniques such as scenario analysis and how various operational risk models work and fit in within the greater framework of operational risk management. Some top-down and bottom-up models are considered.

The last part of this book encompasses the last two chapters, both of which consider how regulators look at operational risk and how regulatory approaches affect banks. The first considers regulatory requirements, particularly those set out by the Hong Kong Monetary Authority and its relationship to Basel II. The final chapter in this book looks at risk governance, outlines and discusses the principles for sound risk management developed by the BCBS and brings the book to an end with a brief discussion of how the various techniques help identify and manage potential events, thus, minimise losses.

This book includes detailed explanations, summaries, tables and charts to help industry professionals develop a sound theoretical framework for their work in the field. Both students and working professionals can benefit from this detailed work produced in collaboration with some of Hong Kong’s most prominent professionals. Aimed at banking practitioners and designed as an essential tool to achieve learning outcomes, this book includes recommendations for additional readings. A list of further readings at the end of each chapter will help readers expand their knowledge of each subject while supplementary readings can help readers dig deeper into specific areas. Essential readings will occasionally be highlighted and these are important for students preparing for the examinations leading to the Associate of the Hong Kong Institute of Bankers designation (AHKIB).

A number of people were integral to the development of this work. Among them it is important to highlight Frederick Au. There are many others whose contributions have been of particular significance in the preparation of this essential reference for banking professionals. Among them are Dr. David Yiu Chau Lam and Amos Chan. The information provided in the collection of Hong Kong Monetary Authority publications were instrumental in developing the chapters on risk control and risk governance, we are grateful for the insightful comments from representatives of the Hong Kong Monetary Authority.

The preparation would not have been possible without the help, advice, support, and encouragement of all these people and dozens more. We would like to extend our sincere thanks to them all.

The Hong Kong Institute of Bankers