Is The Glass Half-Full or Half-Empty?
An RMA-Oliver Wyman survey of bank and nonbank financial institutions around the world reflects a wide diversity of experience in operational risk practices.
Philadelphia, Pa. (June 7, 2007)—Key findings from a survey of large institutions indicate conflicting views about the state of operational risk management. A wide diversity of experience in operational risk practices exists among the 70 large institutions that participated in the RMA-Oliver Wyman study conducted in the first quarter of 2007.
“This survey, representing bank and nonbank financial institutions from around the world, is one of the more extensive benchmarking exercises of operational risk practices in recent years,” said Andrew Kuritzkes, managing director, Oliver Wyman, a leading global management consultancy. “To some extent the survey results can be read like a Rorschach test: Many patterns are evident in the data—reflecting a wide diversity of experience in operational risk practices among institutions and can support both a glass half-full and a glass half-empty view of the state of the discipline.”
The findings also indicate that the industry continues to struggle with regulation and that a point of diminishing returns may have been reached for further enhancements to operational risk measurement. At the same time, more institutions are embedding operational risk management in business lines.
Glass Half-Full View
The development of operational risk management frameworks has advanced considerably over the past few years, with 80% of respondents reporting that their frameworks have moved out of the design and testing phase into production. They also report a significant increase in the level of engagement by senior management in operational risk over the past 12 months and a widespread belief by senior managers in the value of a robust operational risk management framework.
Glass Half-Empty View
Regulatory compliance continues to be a struggle on several of the more difficult operational risk measurement and management challenges, including scenario analysis, capital estimation, model validation, and the use test. Also a majority of respondents do not yet see operational risk management contributing to a reduction in operational losses.
“This latter point is significant,” said Kuritzkes. “Improvements in loss experience are where the returns from investment in operational risk management are expected to materialize.”
Heavy Hand of Regulation
While operational risk management is gaining momentum across the industry, regulation continues to exert a strong influence on the shape of current programs. Half of the respondents say regulatory pressure is the primary driver of operational risk development, and compliance is the second most cited benefit of operational risk management.
Regulatory requirements have created a preoccupation with measurement among banks targeting the Advanced Measurement Approach (AMA) under Basel II, often diverting focus from management initiatives that may have a greater payback in controlling losses. Non-AMA banks, by contrast, are prioritizing steps aimed at improving internal reporting and monitoring of risks and designing better risk control processes.
Reaching the Point of Diminishing Returns for Measurement
The industry may have reached a point of diminishing returns to further enhancements in operational risk quantification. While there appears to be high-level convergence on modeling approaches, significant differences remain in technical details, and no single methodology champion for quantification has emerged. More importantly, respondents indicate that two-thirds of the capital models are not yet Basel II compliant. Many continue to be stymied by capital validation, and some are considering revamping their estimation approaches.
Given the considerable effort devoted to operational risk measurement over the last several years, it may be unrealistic to expect the remaining modeling challenges to be overcome in the near term through either additional data or the advent of new measurement techniques. Instead, the advice to both practitioners and regulators should be not to let the best become the enemy of the good. The focus should be on making the best use of existing analysis, rather than on the continued search for elusive precision.
Empowering Businesses
“Ultimately, the real traction from operational risk management comes from empowering businesses to understand operational risks better, improve risk processes and controls, and reduce the potential for operational losses,” said Kuritzkes.
An increasing number of institutions have reported progress on these dimensions and are focusing on embedding the components of an integrated operational risk framework within business lines. These new initiatives are propelling a shift in operational risk management from a centralized control and compliance function to an active risk management discipline that can add value across the organization.
About the Survey
The Web-based survey was supplemented by telephone interviews with a select group of major banks and input from RMA’s Operational Risk Advisory Council, which provided corroboration of the interpretation of the results and distillation of the main messages.
Two-thirds of the respondents were U.S. based and the remainder based primarily in Canada and Europe. Approximately half of the respondents were large institutions with more than $100 billion in assets. In terms of Basel II compliance, 43% of respondents are currently targeting the Advanced Measurement Approach (AMA). The split between AMA and non-AMA institutions is significant, with the two groups often pursuing different development priorities.
The full results are available only to participants in the survey and attendees at the March 2007 RMA-ORX Global Conference on Operational Risk. To participate in a future RMA operational risk survey, contact Kathy Vitale, associate director, Operational Risk.
About RMA
Founded in 1914, The Risk Management Association is a not-for-profit, member-driven professional association whose sole purpose is to advance the use of sound risk principles in the financial services industry. RMA promotes an enterprise approach to risk management that focuses on credit risk, market risk, and operational risk.
Headquartered in Philadelphia, Pa., RMA has 3,000 institutional members that include banks of all sizes as well as nonbank financial institutions. They are represented in the Association by 18,000 risk management professionals who are chapter members in financial centers throughout North America, Europe, and Asia/Pacific. Visit RMA on the Web at www.rmahq.org.
About Oliver Wyman
Oliver Wyman is building the leading global management consultancy, combining deep industry knowledge with specialized expertise in strategy, operations, risk management, organizational transformation, and leadership development. Oliver Wyman was formed in May 2007 when Mercer Management Consulting, Mercer Delta and Mercer Oliver Wyman came together under one name: Oliver Wyman. The firm employs more than 2,500 staff working out of 40 offices in 16 countries throughout the world. For more information please visit our website at www.oliverwyman.com
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