Operational Risk Advancement

The author maintains that measuring and identification of operational risk is almost rudimentary with old and inconvenient systems for the formal measurement systems while other institutions are at the level of adopting strategies for measuring operational risks. In addition, the author reveals that the existing methodologies are relatively simple with few banks and other financial institutions using advanced techniques and implementing systems for risk management in general and operational risk management in particular.

One of the findings revealed through this dissertation is that operational risk measurement is still a form of art which not only adds economic value and assumes multivariate value but also a top-down and bottom-up approach using sophisticated methods and procedures in measuring risks. The author clarifies that the bottom up approach provides a structural model that is applicable in identifying operational risk causes. The author explores the development and application of the balanced score card in strategic management.

The balanced score card was developed by Drs. Robert Kaplan (Harvard Business School) and David Norton. The balanced score card captures the weaknesses and vagueness of previous management approaches in providing an effective perspective in strategic financial management. The author argues that the balanced Scorecard is a management and measurement system, used in facilitating achievement of organizational goals. The balanced score card, helps in putting actionable plans into practical strategies that help organizations achieve goals and objectives.

Under this section, the author examines scenario based approach in performing evaluation of operational risks. This includes critical examination of the preparation of scenario packages, functional design, system demos and evaluation ( heuristic, lab-based and real-world). The LEVER approach stands for the Loss Estimation by validation Experts in Risk. This method of loss estimation uses scarce and lost data by leveraging on internal and external systems for advanced measurement.

Under this section, the author examines the suitability of using the AMA approach in calculating operational risks. The suitability of the AMA approach is based on its ability to enhance flexibility in operational risk management based on the unique business environment and internal control systems. Ideally, the AMA approach has been adopted under the Basel Committee recommendation and as such remains a key approach in enhancing operational risk management.

The author uses the supervisory Guidance on Operational Risk Advancement Measurement Approaches for Regulatory capital literature propagated under the Federal Deposit Insurance Corporation guidelines for US banks as an example (FDIC 2003). Under this framework, the author establishes that board members in corporations are mandated to have vital control on risk exposures and are therefore expected to put in place strategies for effective risk management (Tshoegl 2004).

The author continues by asserting that operational risk management and implementation of policies and activities remains a vital role of the top level management. The researcher examines the AMA requirements with particular regard to internal and external loses of data that may predispose operational risks. This includes adequate assessment of the business environments, control mechanisms as well as the measurement framework which are implemented to meet the AMA requirements.

This includes identification of the key elements in risk quantification such as frequency and severity of the loss identified through the application of the Aggregate Loss Distribution. Under this section, the author critically examines the importance of risk mitigation measures that are vital in considering the implementation of AMA. As such, it is evident that institutions have to put in place mechanisms for tracking and manipulating data to meet organizational needs in line with the legal requirements and regulations.

The author examines the Industry Technical Working Group (ITWG) which presented a paper on LDA-based AMA (New York Federal 2003). This paper structurally reflects the fundamental elements including internal data, scenario and factors that reflect the unique business environment and internal control systems. This strategy is based on the need to determine the horizon of loss in particular year and elucidate the relationship between risks in all business lines.