The author emphasizes that Basel one was a major breakthrough in international banking supervision although market changes and sophistication of risk management techniques become a huge challenge for industry players. As such, Basel two differs from the original framework in several dimensions with the author maintaining that the dissertation deals only with capital adequacy and capital calculation. In this regard, the author maintains that while Basel one deals explicitly with two types of risk in defining weighed assets, Basel two focuses on calculating risk-weighed assets in risk assessment for financial institutions.
This means that under Basel two, risk assessment has two elements, that is; substantive changes to treatment of credit risk relative to Basel one and the introduction of an explicit treatment of operational risk resulting in capital measure of operational risk. Operational risk has been defined as the risk loss due to inadequate or failure of internal systems or external events. As such, the definition of operational risks deliberately includes legal risks although it excludes reputation claims and strategic risks (BCBS, 2004 P137).
However, Nystrome (2002, p 1) maintains that operational risk is not applicable only to financial institutions and banking companies. Organizations with heavy investments and complex information technology systems have also traditionally employed operational risk management strategies. With globalization and increased internationalization of banking and other financial service ha changed the traditional ways of operational risk assessment and management. In addition, the advancement in computer technology has also led to the development of new and efficient systems for performing risk assessment.
The author points out that operational risk could also be as a result of management mistakes in terms of failure of processes or external events. This is based on the understanding that proper planning, adequate control of processes and functional human resource strategies enhances arrival at appropriate capital charge. In addition, the author also points out that system risk could also result from system failures hence resulting in the disruption of internal and external business processes.
In addition, the author identifies risks emanating from natural disasters and calamities, terrorism, vandalism and violence as some of the external factors that contribute to operational risks. However, a critical analysis reveals that some factors are commonly associated with operational risks. These factors include but not limited to; • Heavy reliance on technology • Proliferation of products using superior technologies in the market place • The expansion of e-banking and resulting exposure to operational risks.
An example of a banks operational risk exposures is the 1. 3 billion dollars lost by the Barring Bank in inappropriate and unauthorized trading arrangements leading to bankruptcy and insolvency of the bank. The author uses this case study to show how failure to comply with the Basel two guidelines has exposed banks and other financial institutions to increased risk due to failure to employ appropriate frameworks for measuring and quantifying operational risks in Bael two regulations.
The author has discussed operational risks in the perspective of European and American banks. In the additional chapter, the author expands his definition to cover Japanese and Islamic banking systems to meet international expectations and requirements. A publication by Bank of Japan (Mori 2001) gives the Japanese perspectives of operational risk definition and management. The Japanese perspective of operational risk is that firms may not necessarily incur direct loses and the profits may no decline in the short run.
However, the loss of public confidence and trust coupled by poor reputation could lead to investors pulling away depriving institutions of much needed capital investments. Such an eventuality would not only harm the institutions affected but would also cause considerable harm to clients and strategic partners. The author notes that operational losses could also be categorized to small-scale problems arising due to clerical errors or whilst remitting small sums to clients.
The author defines Islamic banking as the system of banking or banking activities that are consistent with the Islamic values and principles. Islamic banking has been in practice in most Islamic countries based on the Islamic laws. The author explains that the Islamic Financial Services Board (IFSB) recognizes that failure to comply with regulations and guidelines to be a major exposure to operational risks. As such, there are different frameworks for enacting regulations and frameworks for minimizing the exposure to operational risks.
Nevertheless, through the respective Shari a boards or other relevant boards, jurisdictions are able to cancel registrations for non-compliant organizations. In addition, under the Islamic banking principles, financial institutions are expected to maintain fiduciary responsibility and uphold public trust and confidence. Failure to maintain public positive image leads to loss in reputation hence affecting the company’s ability to attract investments and capital injections. Damage in reputation could also lead to liquidity crisis as clients make abrupt withdrawal of funds presenting a huge challenge.