Operational risk management practices and the role of capital

Author(s): Christie-Veitch, Courtney (2006)

Created 01 Jan, 2006
Categories Working Papers
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Operational risk may be defined as the risk of losses resulting from inadequate or failed internal processes, people and systems; or external events. Recent catastrophic events such as Hurricane Ivan, which disrupted business and commerce in the region, devastating entire islands in its wake, emphasized the fact that financial institutions are not immune to the effects of operational risks. In fact, an effective and robust operational risk management framework must be construed as a prerequisite for sound performance in todayÂ’s challenging marketplace. The consolidation of the financial sector in the region, (particularly through mergers & acquisition) and its concomitant implications for technological systems and personnel, coupled with the heightened interest in client products and business practices ie anti-money laundering, fiduciary breaches and misuse of confidential customer information, have forced Regulators over the last decade to strengthen the regulatory framework, thus ensuring that financial institutions remain safe and sound despite their exposure to operational risk. This paper attempts to locate the current status of operational risk management in the region, its relative importance among other categories of risks, and how this risk is currently being managed by financial institutions. Additionally, the paper will look at the operational risk exposure and regulatory capital nexus of financial institutions in the Caribbean. This paper postulates that operational risk is an important pillar in the risk management architecture of deposit taking institutions, and as such, banks need to hold capital to protect against losses resulting from this exposure.

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