OPERATIONAL RISK

OPERATIONAL RISK

TK 6413Islamic Risk Management

Norhazlina Ibrahim0900127

Nur Aziah Che Abdul Aziz0900323

Prof. Dato’ Dr. Kamaruddin Sharif

Operational RiskDefinition of Operational Risk (IFSB):

IIFS shall consider the full range of material operational risks affecting their operations, including the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. IIFS shall also incorporate possible causes of loss resulting from Sharī`ah non-compliance [1] and the failure in their fiduciary responsibilities [2].

[1]Sharī`ah non-compliance risk is the risk that arises from IIFSs’ failure to comply with the Sharī`ah rules and principles determined by the Sharī`ah Board of the IIFS or the relevant body in the jurisdiction in which the IIFS operate.

[2]Fiduciary risk is the risk that arises from IIFSs’ failure to perform in accordance with explicit and implicit standards applicable to their fiduciary responsibilities. As a result of losses in investments, IIFS may become insolvent and therefore unable to (a) meet the demands of current account holders for repayment of their funds; and (b) safeguard the interests of their IAH. IIFS may fail to act with due care when managing investments resulting in the risk of possible forgone profits to IAH

Examples of Operational Loss Events

Examples of Operational Loss Events

Operational Risk Framework

4 steps in managingOperational Risk

Operational Risk Framework

Operational Risk Processes

Identification of risk through Incident Data Collection (IDC).- Based on 7 event types.- Fraud case need to be reported to eFIDS BNM.

Assessment of risk through Risk Self Assessment and Control Self Assessment (RCSA).

- Questionnaires based assessment.- Risk Scorecard: severity and probability matrix.

Quantitative assessment of risk by using Value at Risk (VaR).

Mitigation of risk through Action Plan, Risk Transfer and Outsourcing.

Monitoring of risk through Key Risk Indicators (KRI).

Operational Risk Dimension

Causes Event

Effect Non-Monetary Losses; e.g. Reputational Damage or Forgone Income

Effect Monetary Losses

Operational Risk Causal

People

Process

Governance

IT System

External

Internal Fraud

External Fraud

Operational Risk Event

Employment Practices and Workplace Safety

Damage to Physical Assets

Business Disruption and System/ Infrastructure Failures

Clients, Products and Business Practices

Execution, Delivery and Process Management

Operational Risk Effect

Legal Liability

Regulatory, Compliance and Taxation Penalties

Loss or Damage to Assets

Restitution

Loss of Recourse

Write-down/ Write-off

Reputation

Business Interruption

Resulted in

Roles & Responsibilities

1st line of defense

1st line of defense

Primary responsibility for the management of operational risk in order that accountability and ownership is as close as possible to the activity that creates the risk thereby ensuring that effective action is taken to manage them.

Primary responsibility for the management of operational risk in order that accountability and ownership is as close as possible to the activity that creates the risk thereby ensuring that effective action is taken to manage them.

Operational Risk Management

Operational Risk Management

2nd line of defense

2nd line of defense

Establishing an independent operational risk management and control process which covers the design, implementation and review of its operational risk measurement and methodology.

Responsibilities include establishing the framework for measurement of operational risk and control.

Establishing an independent operational risk management and control process which covers the design, implementation and review of its operational risk measurement and methodology.

Responsibilities include establishing the framework for measurement of operational risk and control.

Direct responsibility for managing specific operational risk issues pertaining to their field of expertise.

Direct responsibility for managing specific operational risk issues pertaining to their field of expertise.

Independently ensuring that the ORM process is appropriate and functioning as designed by conducting regular reviews of the ORM process and measurement.

Independently ensuring that the ORM process is appropriate and functioning as designed by conducting regular reviews of the ORM process and measurement.

Bank-wide Support Units

Bank-wide Support Units

AuditAudit 3rd line of defense

3rd line of defense

Business UnitBusiness Unit

Incident Data Collection

Incident Data Collection

Risk Control Self Assessment

Risk Control Self Assessment

Risk Control Self Assessment

Key Risk Indicators

Threshold setting is depending on the organization risk tolerance level.

Threshold could have few layers.

Capital Charge

3 methods in calculating capital charge:

1) The Basic Indicator Approach (BIA)- Alpha () is standardized at 15%.

2) The Standardized Approach (TSA)- Beta factors (β) is based on specific 8 BASEL

Business Lines.

3) Advanced Measurement Approaches (AMA)- Risk factors are measured according to bank’s

internal Operational Risk management systemusing quantitative and qualitative criteria.

- Determining the capital requirement is subjectto the Central Bank’s approval.

- To fulfill criteria set before implementing AMA.

Basic Indicator Approach

Formula:

Standardized Approach

Formula:

Standardized Approach

8 BASEL Business Lines:

Standardized Approach

Alternative Standardized Approach (ASA) only for retail and commercial banking business lines:

KRB = βRB x m x LARB

where:

KRB = the capital charge for Retail Banking business line

βRB = the beta for Retail Banking business line

m = 0.035 (replace gross income as exposure indicator)

LARB = total outstanding retail loans and advances (non-risk weighted and gross of provisions), average over the past three years

Gross Income Computation

Net Interest Income A

Comprising:All interest income (excluding interest suspended and recoveries)Less: Interest expense

XXX(x)

Net[1] Non-Interest Income B

Comprising:Net commissions / fees receivable (including outsourcing fees receivable, excluding outsourcing fees paid)Net income from trading book securities (including unrealised gains / losses from fair value changes of trading book securities)Other operating incomeIncluding intra-group incomeDividend income from investment in securitiesOthersExcluding:Dividend income from subsidiaries and associated companiesRealised or unrealised profits / losses from sales or impairment of securities in banking bookIncome from extra-ordinary or irregular itemIncome from insurance recoveries

XXXXXXXXX

Total Gross Income from Islamic Banking Operations Z

Total Gross Income A + B + Z

Net income from financing activities A

Net income from investment activities B

Other income:Realised / unrealised gains / losses from sales or fair value changes of trading book securitiesNet commission / fees receivablesIntra-group incomeDividend income from investment in securitiesIncome from non-Shariah compliant sourcesOthersExcluding:Dividend income from subsidiaries and associated companiesRealised or unrealised profits / losses from sales or impairment of securities in banking bookIncome from extra-ordinary or irregular itemIncome from insurance recoveriesBad debt recovered

C

Less:Income attributable to investment account holders and other depositors

D

Total Gross Income (Z) A + B + C - D

Gross Income Computation

Islamic Banking Operation

Thank You