Narrow risk definition being broadened

By MARTELLA MATTHEWS,Guardian Business Reporter martella@nasguard.com

The narrow risk definition held by most banks and financial services firms will be broadened as institutions worldwide prepare for the 2006 implementation of the Basel II Capital Accord that will expand the scope of risks faced by financial institutions to include operational risk.

According to the Basel Committee on Banking Supervision consultative document, this expanded approach to risk for financial institutions was developed to address the growing realisation that financial institutions are faced with other substantial risks that do not include the traditional market and credit, which most banks and financial institutions usually allocate for.

Emphasising the need for the new Basel accord, Steve Giles, an expert in the area of corporate governance and risk management told The Guardian that unlike most other types of industries, financial services institutions tend to have a less inclusive definition of risk. He said in most industries, risks faced by a particular company would also include factors such as reputation and operational risk.

Mr. Giles noted that with this new accord set out by the Basel Committee, it is being made quite clear to financial services firms that the previously narrowed definition of risk would have to change which could mean for a number of institutions, rethinking how they monitor and measure operational risk. "The whole thrust of Basel II is increasing the capital buffer of banks so that they can cover not only market risks, not only credit risk but also operational risk," he said. "So its important that banks look at it very seriously because it might mean at certain institutions that they will have to increase their capital cover."

Expanding on the concept of operational risk, Mr. Giles, whose back ground in financial services include a specialisation in investigative and forensic accounting at Deloitte and Touche, United Kingdom in the late 1990's, explained that at its most basic level it addresses problems that can result from people, systems controls and outside events. This he noted could include possibilities ranging from a glitch in an organization's computer system to the 2001 tragedy of Sept. 11.

Focusing on the risks that the people in an organisation could present that should be allocated for, Mr. Giles said that people could make errors, either as a result of in competency or fatigue, which could inadvertently lead the institution into a loss situation. Or he added, there was also the risk of a more deliberate form of error, fraud. In addressing these issues, he noted that a financial institution would have to look at how to manage these risks and whether or not the institution has the proper response plans or controls in place to deal with these types of events.

The forensic accountant said that while the responsibility for setting up the risk profile of an institution would traditionally fall on directors and management, sometimes an outside person might present a more independent view of how things are managed and organized in the institution. "Sometimes you can be anchored in the past very often if you're management, it's very difficult to change because you will think the way that you have done things are pretty good. And there are always ways you can improve them," Mr. Giles said.

Once the risks have been identified, Mr. Giles suggested that to ensure these risk profiles are adhered to a key step would be to raise the awareness of the risks throughout the organization. "That's from chief executive straight through to junior clerk. You really try and get that risk awareness into an organisation's corporate DNA," he said.

Mr. Giles along with the Bahamas Institute of Financial Services will run a three-day seminar on operational risks and corporate governance at the Goodman's Bay Corporate Centre beginning today. The seminar will look specifically at risk management and fraud and will provide an in depth look at organisations in the United Kingdom and the United States that have succeeded and failed in this area and how the respective jurisdictions have attempted to deal with these failures.

Mr. Giles noted that while each bank has an individual responsibility to look after its own interest with respect to risk management, the Central Bank is entrusted with the responsibility of protecting the reputation of the entire jurisdiction. He lauded the efforts made by the Central Bank thus far in implementing procedures that has and will protect the jurisdiction from potentially damaging reputation risks explaining that the existence of a single rogue bank could impact the reputation of the entire industry as a whole.

Caption: Keith Checkley of Keith Checkley and Associates, United Kingdom (L) and Steve Gile, Highview Consultants, U.K. talk about operational risks and the proposed Basel II Capital Accord to be implemented by financial institutions worldwide in 2006.