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The growing impact of operational risks and its application to banks

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  1. How could we define the operational risks ?
    1. Why a new category of risks has been created?
    2. The creation of the Basel II Accords
    3. The Basel II Accords' exigencies
    4. How the operational risks are managed by the banks?
  2. The management of the operational risks
    1. The operational risks management at the Dexia BIL (Luxembourg)
    2. The management of the operational risks in France
    3. Jérôme Kerviel's case: a new shock for the financial market
    4. The limits of the operational risks management

Since their implementation in the banks in January 2007, operational risks are considered a main point of the strategy of banks. Operational risks are defined as ?the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events1.? The Basel II Accords, signed in June 2004 and officially implemented in banks in January 2007, give the banks the guidelines to follow when dealing with their operational risks. By following those guidelines, the banks will improve the management of their operational risks and decrease their exposition to those risks. The aim of this report is to point out how important the management of the operational risks for the banks is. It was necessary for the financial institutions to take into account the evolution of the operational risks at the end of the last century. Several events such as the Barings' bankruptcy or the terrorist attacks on New York City in 2001 sounded the alarm bell. That is why the Basel Committee wanted to improve the management of the operational risks through the new regulations included in the Basel II Accords. By improving the management of the operational risks, the banks would reduce their exposure to those risks and decrease their operational losses. Though these changes represent a big effort and huge investments for banks, their repercussions are very beneficial. The reduction of the banks' exposition to the operational risks will permit them to avoid traumatisms such as the Barings experienced ten years ago. The application of the Basel II Accords has a positive effect on the banks' costs as well as on the banks' revenue. In fact, by imposing new regulations on the banks, those accords also proved to be profitable for the banks' client. The new banking rules have the advantage of improving the quality of the banks' services. Since the implementation of the Basel II Accords in January 2007, analysts thought that the banks were totally protected from the operational risks by them. However, the several internal frauds that touched the banks since the sub primes crisis in summer 2007 questioned the banks' management of the operational risks and pointed out that the banks still need to improve the management of those risks. The Basel II Accords were written by the Basel Committee on Banking Supervision in June 2004. Since this date, every bank had to prepare itself in order to be ready on January 2007 to implement the new Basel II regulations. These new regulations had a deep impact on the organization of the banks. All banks need to rethink the way they have been organized in the past in order to integrate the management of the operational risks. Indeed, the Basel II Accords impose new criterion to respect in order to protect the financial institution from operational risks. Now that the operational risks are considered a risk category (such as the market and the credit risks), they have a deep impact on the business of the banks. That is why it is important for banks to take those risks into account.

[...] In fact, even before the creation and the application of the Basel II accords, banks were already aware of operational risks and were already trying to handle this kind of risks Before January 2007, banks were organizing their activities by creating a procedure for the employees to follow, and an internal audit was in charge of verifying the relevance and the good application of those procedures. However, as the operational risks were not clearly defined, they were hard to manage and, and it was difficult to reduce their exposition to those risks. [...]

[...] The management of the bank's operational risks has to follow the evolution of the institution and the evolution of its market. To retain the model's efficiency, the bank will have to review the bank's activities from time to time. This way, the bank will be able to evaluate the evolution of the activity and the new risks that appeared. This review will permit the bank to create new processes and to cancel or adapt the obsolete ones. As we have seen, the operational risks management does not stop when the risks are identified, quantified and controlled. [...]

[...] By adding incidents that happens to its competitors, the bank is enlarging its sample and is now able to reach a more complete view of the operational risks present on its market. However, the bank has to be careful in the analysis of the external data because the incidents that touch the other banks are subjective. Indeed, the exposure to the operational risks is different from bank to bank. Thus the nature of the incidents has to be analyzed deeply, because some risks could result from the difference of the structure in another bank. [...]

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