Hedge Funds and Their Implications for Financial Stability
Tomas Garbaravicius and Frank Dierick, European Central Bank, occasional paper series, August 2005
This paper looks at the hedge fund industry and its possible effects on lending institutions and the financial industry, with a special emphasis on risk management. The paper notes the positive effects that hedge funds have on the financial industry (e.g., extra liquidity, diversification benefits to investors). It says the main threat to financial institutions from hedge funds comes from the role of some banks as prime brokers - these institutions extend the credit that allows hedge funds leverage their capital, and by proxy they assume some degree of hedge-fund market exposures. Large credit institutions, the paper says, are also now engaging in "hedge fund-like strategies" that may expose their proprietary market positions to more risk. The paper says that the situation with regard to hedge fund risk is better than before the Long Term Capital Management crisis, but that regulators must continue to press for more information.

Outsourcing in Financial Services
Bank for International Settlements, Joint Forum, 15 February 2005
This report tries to establish a baseline of good practice in respect of outsourcing by banking institutions. It puts forward various principles with regard to outsourcing policy and risk management, partly to help supervisors take outsourcing risk into account in their review of firms. The most fundamental principle is that the bank’s senior management must remain responsible for all the bank’s activities, whether or not these have been handed over to a third party for execution.

Putting an End to Account Hijacking Identity Theft
Federal Deposit Insurance Corporation, 14 December 2004
Account hijacking has turned into a major problem for the US banking industry, catching out maybe two million people a year. It threatens to slow down the rapid expansion of internet banking. This study reviews the problem and says that financial institutions should introduce more safeguards. These include using scanning software to guard against phishing attacks; customer education programs; sharing information more readily across the industry; and using two-factor customer authentication procedures.

The Management of Hedge Funds’ Operational Risks
Jean-Rene Giraud, Edhec Risk and Asset Management Research Center, April 2004
It would be natural to assume that the biggest risks facing a hedge fund are market risks. This paper, however, suggests that the key risks are fundamentally operational in nature – for example, the procedures that govern the valuation of assets – even if they arise in part from the specialized trading strategies of hedge funds. At least 56%  of hedge fund collapses, the paper says, are directly related to failures in operational processes. It follows that, for investors, operational risk due diligence on a hedge fund may be an important selection criterion.

Implications of Alternative Operational Risk Modeling Techniques
Patrick de Fontnouvelle et al., NBER Project, June 2004
This paper compares operational loss data drawn from six large internationally active banks, and looks at the implications for bank risk capital. It finds that operational risk loss data, when analysed by type of event, shows some broad similarities across the banks. For example, the category Clients, Products and Business Practices tends to exhibit the most severe kinds of event, while the category External Fraud and Employment Practices gives rise to the least severe events. The losses the banks suffered suggested that a typical bank in the research sample would need to set aside about 5-9% of current minimum regulatory capital to cover itself against operational risk. However, this number is based on internal data alone, and the authors recognize that banks need to add on additional capital to cover themselves against risks revealed by their analysis of external operational risk data, hypothetical scenario analysis, and so on. The authors’ reckon that their 5-9% finding is therefore consistent with the 12-15% of regulatory capital that most banks seem to currently allocate to operational risk.

Assessing Operational Risk in CHAPS Sterling
Paul Bedford et al., Financial Stability Review, June 2004
This paper describes a series of simulations and experiments that were designed to test the operational resilience of the UK’s CHAPS Sterling payments system – an important piece of infrastructure to the UK banking industry. The simulations seemed to show that the system is indeed very resilient, though the authors could not discount some degree of liquidity risk should an operational incident affect multiple settlement banks on the same day.

Offshore Outsourcing of Data Services by Insured Institutions and Associated Privacy Risks
Federal Deposit Insurance Corporation, June 2004
With some analysts claiming that banks can save 40-75% of costs by outsourcing some key functions, it is not surprising that US financial institutions are now “offshoring” their workload – often to lesser developed countries. However, the trend has many significant implications for how banks manage their operational risks, particularly as it becomes more common to outsource entire business processes rather than distinct projects (such as IT development). This study focuses on the reputation and privacy aspects of offshoring and makes various recommendations concerning good practice.

Capital and Risk: New Evidence on Implications of Large Operational Losses
Patrick de Fontnouvelle et al, Federal Reserve Bank of Boston working paper, September 2003
This paper uses data from data-vendors OpRisk Analytics and OpVantage to put a number on operational risk losses in the banking industry – and implied economic capital requirements.  Operational loss data is notoriously patchy and prone to bias, and the authors rely on extreme value theory to extract a loss probability distribution from the data.  They conclude that operational risk is indeed an important source of bank risk and that the capital charge for operational risk will often exceed the charge for market risk; that accounting for reporting bias in external data significantly reduces the estimated operational risk capital requirement; and that supplementing internal data with external data on extremely large rare events significantly improves bank models of operational risk. They find that the distribution of observed losses varies significantly by business line, but are unable to say whether this is driven by cross-business line variation in the underlying loss distribution, or simply by variation in the sample selection process.

The Invention of Operational Risk
Michael Power, ESRC Centre for Analysis of Risk and Regulation, June 2003
This paper takes a wry look at how the banking industry launched its project to collect together disparate risks and risk management techniques under the rubric “operational risk”. The author describes how the effort to create an operational risk discipline has led to “a collision between the disciplines of auditing and finance, the one a humble and pragmatic craft…the other drawing upon advanced mathematical techniques to model market and credit risk”. He believes that the struggle to define operational risk, collect data and develop capital models can’t be separated out from “a new intra-organisational politics, in which …the allocation of responsibility and status are strategic stakes”. Meanwhile, Basel II has become, “a regulatory programme on the grandest of scales, projecting an ideal, a fantasy perhaps, of hyper-rational management for the global banking system”.

Operational Risk Transfer Across Financial Sectors
Basel Committee Joint Forum, August 2003
This paper looks at the pros and cons of transferring operational risk across financial sectors, particularly from the banking to the insurance industries by means of insurance contracts. Among its conclusions: supervisors and firms should understand better the effectiveness of operational risk transfer mechanisms and the attendant risks; firms that take on risk should have in place adequate risk management and measurement systems; supervisors should share information within and across sectors; and protection sellers should focus efforts on improving existing operational risk transfer products rather than attempting to offer broader “basket” coverage.

Evolving Operational Risk Management for Retail Payments (paper EPS-2003-IE)
Paul Kellogg, Emerging Payments Occasional Papers Series, Chicago Fed, 2003
Payments systems such as checks, credit cards and ATM machines yield up to 20% of some regional banking revenues. But payment systems are undergoing radical change as traditional batch processing gives way to electronic, even real time, processing. This paper highlights four top concerns for banks engaged in payments: changing delivery channels and safeguards; fraud; vendor and outsourcing oversight; and operational risk measurement and reporting.  It concludes that while risk management practices are evolving to meet current and emerging risks – particularly through the development of self-assessment techniques, key risk indicators, and better loss reporting – bank management should increase their effort to make sure the overall risk is reported to senior management and Directorates. The paper includes a discussion of operational risk frameworks for retail payments and describes key elements of this framework (such as Key Risk Indicators).

Network Vulnerabilitities and Risks in the Retail Payment System ( paper EPS-2003-1F)
Catherine Lemieux, Emerging Payments Occasional Papers Series, Chicago Fed, 2003
Operational risk events during 2003 - including the downing of a major US bank ATM system as the result of a virus, and the loss to a hacker of millions of credit card numbers - have highlighted the vulnerability of retail banking systems. This paper notes that the consolidation of outsourcers, and the increasing use of foreign firms with weaker internal controls to perform outsourced functions, are two reasons to doubt the resiliency of retail payment systems. However, the existence of multiple retail payments options, the absence of large losses as a result of network vulnerabilities in retail payment systems, the availability of alternative IT vendors, and the ability of technological solutions to limit the risk, all serve to reduce systemic concerns – though the author feels more research is required.

Policy Issues for Central Banks in Retail Payments
Bank for International Settlements, March 2003
This report, aimed at policy makers in central banks, offers a broad view of retail banking trends from a risk perspective including industry innovations, cross-border payments, new market participants and so on. The paper focuses on the role of central banks in retail payment systems and on future public policy goals. Annex A summarises some of the main areas of innovation in retail payments from a product standpoint, such as the emergence of ATMs in some countries that allow bill paying, credit transfers and other services.  (Other BIS papers available through this page offer general surveys of retail payments systems in various countries; a 2003 ECB policy paper on oversight standards is available here.)

Risk Management Principles for Electronic Banking
Basel Committee, July 2003
This paper offers 14 broadbrush principles for electronic banking in relation to board and management oversight; security and controls; and legal and reputational risk management. The Committee says that electronic banking increases and modifies the traditional risks associated with banking, particularly strategic, operational, legal and reputational risks. This is in part due to the ubiquitous and global nature of open electronic networks, the integration of e-banking applications with legacy computer systems, and the increasing dependence of banks on third parties that provide the necessary information technology. The Committee says the integration of e-banking applications with legacy systems “implies an integrated risk management approach for all banking activities of a banking institution”.

Conflict of Interest Findings on Citigroup and Morgan Stanley
New York State Attorney General Eliot Spitzer’s Office, April 2003
As part of a landmark “global resolution” of investigations into Wall Street banks by state and federal authorities, New York Attorney General Eliot Spitzer published findings from his office’s investigation of conflict of interest problems at two of the US’ largest investment banks at the end of April 2003. Spitzer’s office was responsible for investigating Citigroup’s Salomon Smith Barney, now called Citigroup Global Markets, and Morgan Stanley. The main points of the findings are summarised here, alongside links to some of the raw evidence, while the full findings for Citigroup are here and for Morgan Stanley here.

The 2002 Loss Data Collection Exercise for Operational Risk: Summary of Data Collected
Basel Committee Risk Management Group, March 2003
This paper summarises the data collected through the 2002 Operational Risk Loss Data Collection Exercise (LDCE), launched by the Risk Management Group of the Basel Committee on Banking Supervision in June 2002. The 2002 LDCE asked participating banks to provide information on individual operational losses during 2001, internal capital allocation for operational risk, expected operational losses, and a number of exposure indicators tied to specific business lines. This paper provides an analysis of the range of individual gross loss amounts and of the distribution of these losses across a set of standardised business lines and event types; it includes some information on insurance and recoveries, and on the economic capital that participating banks allocated to operational risk. (The third consultative paper on the proposed New Basel Accord, released 29 April 2003, is here and includes the almost-final operational risk proposals.)

Modelling Operational Losses
Ancus Roehr, Algo Research Quarterly, Summer 2002
In order to calculate operational risk capital, many banks have begun to collect operational loss data. Pools of loss data are also being gathered in industry-wide initiatives by regulators, banking associations and private external vendors. This article addresses the question of how to set up an actuarial loss model with such heterogeneous data. Special consideration is given to sets of losses in excess of various thresholds and how these might be combined to calibrate a single model. The sensitivity of model parameters to those varying thresholds is also analysed. (For the full contents list of the Algo Research Quarterly of Summer 2002, devoted to operational risk, click here.)

Dependent Events and Operational Risk
Miro Powjowski et al, Algo Research Quarterly, summer 2002
Operational losses are often linked in terms of their cause or effect. This paper demonstrates that including such correlations in the calculation of operational capital can have a significant effect on the level of reserve capital required to cushion against the risk of operational loss. Modelling loss correlation, however, is a complex issue. The paper focuses on positively correlated events that arise from a single root cause, and offers an example of how such events might be incorporated into operational risk measures. (For the full contents list of the Algo Research Quarterly of Summer 2002, devoted to operational risk, click here.)

Sound Practices for the Management and Supervision of Operational Risk
Basel Committee Risk Management Group, February 2003
This paper outlines a set of principles that provide a framework for the effective management and supervision of operational risk. The framework is likely to be employed by both banks and their supervisory authorities to evaluate operational risk management policies and practices. It identifies certain crucial elements of operational risk management: clear strategies and oversight by the board of directors and senior management; a strong operational risk culture and internal control culture (including, among other things, clear lines of responsibility and segregation of duties); effective internal reporting; and contingency planning.

Managing Operational Risk in Payment, Clearing and Settlement Systems
Kim McPhail, Bank of Canada, working paper, February 2003
Payment, clearing, and settlement systems (PCSS) consist of networks of interconnected elements such as central operators, participants, and settlement agents. Operational problems at any one of the key elements can disrupt the system as a whole, causing significant losses at individual institutions and exacerbating other risks such as market, liquidity, and credit risk. At the extreme, a failure in PCSS could pose a risk to national or international financial systems. The author of this paper describes the key features of systemically important PCSS in Canada and offers a new approach to analyzing PCSS risk based on a loss-distribution methodology adapted from the management of operational risk at individual financial institutions.

Payment and Settlement Systems in Selected Countries
CPSS Publications No. 53, April 2003
This is the fifth edition of a major industry publication that describes payment arrangements in various countries. The so-called ‘Red Book’ is produced by the BIS-sponsored Committee on Payment and Settlement Systems (CPSS). The Committee notes that, in recent years, issues relating to the financial risks of all types of payment arrangements have come to the fore. This edition contains a chapter on international payment arrangements and a comprehensive glossary.

What is Operational Risk?
Jose A. Lopez, FRBSF Economic Letter 2002-02, January 2002
This short note from a regulatory journal introduces operational risk in a readable fashion for newcomers to the field. It offers short comments on defining operational risk, measuring operational risk, mitigating operational risk, and capital budgeting for operational risk.

Bank Operational Risk Management: More than Just an Exercise in Capital Allocation and Loss Data Gathering?
Sam Theodore, Moody’s Investors Service, June 2002
As this report makes clear, analysts at the main ratings agencies place increasing importance on operational risk when assessing bank credit ratings. Moody’s says it believes that the use of quantitative criteria for operational risk management is only part of the process, whether building a loss database for the bank or trying to predict expected operational losses through statistical models. What remains critically important is the implementation of an effective qualitative process of identifying, measuring, managing and controlling operational risk throughout the organisation. And that is particularly true if banks are to manage their exposure to the really catastrophic operational event losses that can capsize financial institutions.

The True Cost of Operational Risk
Rob Jameson, ERisk, February 2002
This ERisk editorial feature, based on interviews with leading bank practitioners, explains why putting a number against operational risk has become such an urgent issue in many sophisticated banks (particularly those that use economic capital to make strategic decisions). It explains why measuring operational losses is not the same as measuring operational risk: routine or expected levels of loss can be thought of as costs, while risk measurement should focus on volatile and unexpected levels of loss. We contrast ‘top-down’ approaches to the measurement of operational risk to ‘bottom-up’ approaches based on business line information, outlining the steps towards a simple top-down approach employed at one global bank. With the help of practitioners from BNP Paribas and the Bank of Montreal, the paper also compares approaches based on hard data  (such as historical losses and key risk indicators) to those based on subjective data (such as business line assessments of risk exposures and audit scores). We conclude that banks often adopt hybrid ‘top-down’ and ‘bottom-up’ approaches, with the intention of building out their methodologies as more data becomes available.

Internal Measurement Approach to Operational Risk Capital Charge
Toshihiko Mori and Eiji Harada, discussion paper, Bank of Japan, March 2001
Written by a manager and an analyst at the Bank of Japan, this paper begins with a brief overview of how operational risk is related to the concepts of operational hazards, events and loss amounts. The paper then focuses on the structure of the Internal Measurement Approach (IMA) to operational risk, discussing key elements such as the definition of operational loss, methods of parameter estimation, calibration of supervisory scaling factors, and the structure of loss databases. A simplified methodology for incorporating the mitigation of risk through insurance is proposed in the final sections. (This page lists some earlier and related papers from the Bank of Japan; note also regulatory developments since this paper was written indicating that the Basel Committee accepts the need for flexibility in the development of advanced measurement approaches.)

Solutions On Measuring Operational Risk
Junji Hiwatashi, Capital Markets News, Federal Reserve Bank of Chicago, September 2002
This overview of developments in operational risk measurement was written by an officer of the Bank of Japan on secondment to the FRBC. It links the hoped-for benefits of measuring operational risk to a characterization of key methodologies. It tabulates some ‘top-down’ and ‘bottom-up’ approaches to the problem, and discusses some key hurdles to developing sophisticated operational risk measures in the global banking industry.

The Near-Miss Management of Operational Risk
Alexander Muermann and Ulku Oktem, Wharton School Insurance and Risk Management Department, 2002
This working paper introduces the concept of “near-miss management”, a pragmatic approach to operational risk that has been developed in the chemical, health and airline industries. The authors review traditional and developing approaches to operational risk management, arguing that the near-miss approach offers a complementary methodology. They point out that low-impact/high frequency events should not be ignored simply because their loss severities push them towards the “expected” category of losses. Instead, they should be seen as signalling weaknesses that set the scene for potentially catastrophic disasters. The near-miss approach would allow the development of an advanced management approach in line with the Basel Committee’s latest proposals and allow risks to be assessed and managed internally in a dynamic and integrated way.

Operational Risk Insurance – Treatment Under the New Basel Accord
Hal Scott and Howell Jackson, working paper, Spring 2002
This paper looks at the risk management process in banks with regard to insurance, noting the ways in which insurance already mitigates certain key bank risks. It looks at the strengths and weaknesses of insurance as a way of mitigating the economic effects of risk events, and explores how operational risk insurance might be incorporated into the structure of the New Basel Capital Accord. The authors say that many industry efforts mandated by the Accord, from industry-wide data collection to operational risk modelling, can serve as tools for developing better insurance products. But they doubt whether sufficient information will be available to solve the problem of operational risk insurance before the Accord comes into play in a few years’ time. (An earlier substantial paper on operational risk insurance by the Operational Risk Research Forum was submitted to the Basel Committee in May 2001 and is available here. A similarly themed paper submitted to the Basel Committee by insurance companies and published in November 2001 is available here.)

Using Bayesian Networks to Predict Op Risk
Martin Neil and Ed Tranham, Agena/Operational Risk newsletter, August 2002
This short technical article looks at how Bayesian networks can be used to identify organizational vulnerabilities. In particular, the authors argue that Bayesian techniques can be used to bring together the very different kinds of information (subjective, quantitative, judgemental and so on) that operational risk managers use to gain insight into their institutions’ risk profiles. They say that the advantage of using Bayesian techniques to do this is that they offer the best methodology for “reasoning under uncertainty” and offer a clear, auditable trail of an operational risk manager’s thinking.

The Regulation of Operational Risk in Investment Management Companies
Charles Calomiris and Richard Herring, Perspective vol.8/2, Investment Company Institute, September 2002
This paper looks at the extension of capital standards for operational risk to investment management companies. It argues that approaches other than reserving risk capital (especially private insurance) might be a more effective way of controlling operational risk in this sector of the financial services industry. The authors point out that investment management companies lack the ‘moral hazard’ and public insurance elements that have attracted the attention of bank regulators to the problem of operational risk capital. The paper also summarizes the approaches of the EU and the Basel Committee regulators, identifying some key practical problems.

Operational Risk Management for the Buy Side
Report of the International Association of Financial Engineers, November 2002
According to one database of operational risk events, publicly reported operational risk events have cost the fund/investment management community around $9 billion over the past ten years. This document reports on a discussion of the problem by a panel of buy-side experts, drawn together in October 2002 by The Operational Risk and Investor Risk Committees of the International Association of Financial Engineers (IAFE). The panel reckoned that buy-side firms should do more in terms of de-briefing senior managers on the causes of disasters in their sector – using real-life case histories – and that buy-side firms should have a special focus on ‘breach of fiduciary duty’ risks. They also believed that operational risk best practices will become standard in the industry; that operational risk management is a business imperative at least as much as a regulatory imperative; and that business unit interests must be aligned with those of the institution as a whole. However, they thought that cost cutting in the sector would pose a serious challenge to operational risk management initiatives.

The Role of Insurance in Managing Extreme Events: Implications for Terrorism Coverage
Howard Kunreuther, Center for Risk Management and Decision Processes, The Wharton School, University of Pennsylvania, 2002
How should the financial industries think about the risk management of extreme physical risks that are difficult to quantify, such as major technological accidents and terrorist activities? And what division of responsibility might there be between governments and the insurance industry in ensuring that companies can gain cover for such risks? These have been key questions since the September 11 terrorist attacks in the US. This working paper sets up a scenario to illustrate the challenges and opportunities facing the insurance and reinsurance industry in this regard. It also addresses some more general issues that relate to operational risk in the financial industries, such as the high premiums charged by the insurance industry for any ambiguity or uncertainty about the nature of a risk.

Operational Risk Capital Allocation and Integration of Risks
Elena Medova, Cambridge University, Judge Institute Working Paper, 2001
Modelling and measuring operational risk have been hot topics in the financial services industry since it became clear that the proposed New Basel Capital Accord will require banks to set aside capital against these risks. This paper presents an integrated risk capital framework for the measurement of operational risk in terms of extreme losses. The framework is based upon the assumption that, for a well-managed bank, the capital set aside to cover market and credit risk also offers a threshold for the identification of the size of any 'extreme losses' that might be characterized as 'operational' from the regulators' viewpoint. The capital allocation rule described in the paper attempts to link operational with market and credit risks, and provides a risk measure for the tails of loss distributions at both the firm-wide and business unit levels.

Near-miss Management Systems in the Chemical Process Industry
James R. Phimister et al., Wharton School of Management et al., Risk Management and Decision Processes Center, November 2001
Extreme operational losses at financial institutions rarely come out of the blue. Instead, they are nearly always preceded by a series of more minor losses, mishaps and rule infringements. This pattern has also been observed in other industries such as the transport, aerospace, nuclear and chemical industries. Many safety experts now believe that accidents such as the 1999 Paddington train crash in the UK and the 1986 Challenger space shuttle explosion in the US could be prevented if 'near-miss' precursors to major events are identified and managed. This paper focuses on the improving near-miss programmes in the chemical industry, but yields many general truths about the near-miss approach to risk management. The authors argue that to improve near-miss management systems, managers must focus on the details of a seven-stage process by which near misses are reported and analyzed: 'Identification' of a near-miss, 'Disclosure' and 'Distribution' of relevant information, 'Direct and Root Cause Analysis', 'Solutions' to prevent recurrence, 'Dissemination' of remedial action, and 'Resolution' through tracking. But they argue that it is also important to avoid cumbersome reporting and analysis of each near-miss, as this can itself damage the safety process.

Foreign Exchange Settlement Risk in the East Asia-Pacific Region
EMEAP Working Group on Payment and Settlement Systems, December 2001
Foreign exchange settlement risk, or Herstatt risk, is the risk of principal losses on foreign exchange transactions as a result of a cocktail of operational risk and credit risk. Typically, a loss occurs when a bank irrevocably pays away the currency it has sold but, due to the failure of its counterparty, does not receive the currency purchased. This study, by the members of the EMEAP Working Group on Payment and Settlement Systems, surveys the foreign exchange settlement practices of commercial banks within the Asia-Pacific region. It describes many sound risk management and back-office practices amongst banks in the region, but finds that many banks still do not formally agree with their correspondent banks a deadline for cancelling instructions to pay away a sold currency; fail to identify final settlement; and make little use of bilateral netting to reduce exposure.

Insurance Council of Australia Background Paper On Reinsurance
Insurance Council of Australia, Royal Commission website, 2002
The Royal Commission on Australia's largest financial institution failure - HIH Insurance Group in March 2001- has postponed publication of its final report on the debacle from June 2002 until February 2003. But the enquiry is beginning to yield some useful information, including this background paper, posted on the Commission's web site. The paper is designed to help the enquiry, and other interested professionals, to understand the role of re-insurance contracts in financial failures. It explains the key aims and terminology of the principal contracts and markets, and examines the potential for confusion between funding contracts and those that aim to transfer risk. Other background papers and Commission proceedings, including an official chronology of events leading up to the HIH collapse, are available here. The ERisk HIH case study, written in mid 2001, is here.

Managing Operational Risk: Making Basel Effective
TCA Consulting, August 2001
Free registration required
This report assesses how quickly new ideas about operational risk management – particularly those included in the Basle II reform proposals – are being adopted by banks. The report is based on research conducted in May and June 2001 with 50 bank professionals drawn from bank operations, risk management and heads of business at 32 banks. It finds that there is scant evidence of the concept of ‘business ownership’ of operational risk, with some bank employees implying that operational risk was a matter for the risk management department, rather than themselves. There is also confusion over what is meant by the term ‘operational risk’, and little knowledge about the available tools and methodologies for managing the risk. Some related regional data are contained in KPMG’s, The New Basle Accord – KPMG Global Survey - Australian Perspective, August 2001.

New Trends in Operational Risk Insurance in Banks
Simon Ashby and Brendan Young, Autumn 2001
This article, which recently won a Lumina award in a competition set up by Global Reinsurance to promote risk research, reviews the effectiveness of three interesting developments in operational risk insurance for banks. These developments are basket insurance products, pre-claim settlement cash advances and securitisation. The paper argues that these developments offer banks the chance to improve the financial management of their operational risks. However, it suggests that there are many supply-side issues that need to be resolved before their full potential can be realised.

Schroders Forges its Op Risk Sword
Richard Pike, May 2001
This marketing case history by a financial software firm describes the development of an automated operational risk reporting and management system for a fund management unit of Schroders. It tells how the firm first mapped its the risks and controls in its business and processes, and then established a measurement and reporting system.

Operational Risk – A Case History
Raft International, Autumn 2001
This marketing case history by a financial software firm tells how the firm worked with investment bank Dresdner Kleinwort Wasserstein to develop an automated system for collating and managing operational risk data. Includes comments from the head of operational risk at the bank.

Regulating and Supervising Operational Risk for Banks
Hans Geiger, Swiss Institute of Banking, Zurich University, October 2000
Based on an analysis of the definitions of operational risk and its demarcation versus credit and market risk, this paper argues that it would be inappropriate to introduce extra capital charges for operational risks in Pillar One (capital charges) of the Basle II reforms. It says that the real answer lies in the supervisory review process, and in the effective use of market discipline. Many of the arguments remain interesting and relevant, though as ERisk’s Basle II Special Report explains, the regulators have not taken Professor Geiger’s advice.

Measuring Operational Risk in Japanese Major Banks
Toshihiko Mori, Junji Hiwatashi, and Koukichi Ide, Bank of Japan Research Paper, July 2000
The methods of measuring operational risks can be divided into a top-down approach and a bottom-up approach to allocating economic capital, and this research paper says that large Japanese banks are targeting the latter approach. This is because the latter can be directly related to risk management as well as to internal capital allocation and performance evaluation. The paper then discusses statistical measurement approaches and scenario analyses.

Applying An Agency Framework to Operational Risk Management
Elizabeth Sheedy, MacQuarie University Applied Finance Centre, 1999
This paper argues that the key outstanding issue for risk management is not market risk, credit risk or even operational risk, but agency risk. Will those who wield power over the destiny of a firm, and the risks that it assumes, really act in the interests of the owners or stakeholders? The paper suggests that banks might need to pay more attention to agency issues – and to the character of their employees.

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