A Study on the Determinants of Operational Risk in Public Sector Banks

Subha P.S. Pradha, Krishnaiah J

Abstract


 

 

Global financial industry has undergone tremendous changes owing to intense competition, growing customer expectations, increased regulatory requirements and proliferation of financial innovations. Integration of services across sectors owing to financial convergence became common blurring the boundaries across financial markets. One such sector that has undergone significant transformation is the global banking system.

In the past, banking environment in India was regulated and was having a limited risk exposure. However, present day banking is exposed to numerous risks because of its increased level of operations and diversified services the banks offer. Liberalization of banking services has brought to the fore a plethora of financial innovations. These financial innovations in terms of products and services in the banking industry as well as financial convergence with other sectors have created huge business opportunities for banks. At the same time, they have made the banks vulnerable to many risks that were not known of earlier. More importantly, these risks have a contagion effect and are capable of bringing down the entire financial system down as was evident in the 2008 global financial crisis.

The growing complexity of banking transactions and those of allied sectors have led to an increased probability of failures from the operations perspective. Operational risk losses have led to the debacle of many financial institutions, the prominent ones ranging from The Barings Bank, The Enron, Allied Irish Bank and our own Global Trust Bank. The regulators are enforcing greater awareness among top management and compliance to operational risk management measures as specified by Basel committee from time to time. The Basel norms require banks to specifically focus on operational risk by identifying, measuring, evaluating, controlling and managing this all pervasive risk. This mandates a sound operational risk management framework in banks.

The present paper studies the critical factors influencing operational risk among the public sector banks based in Hyderabad. A sample of 100 branch managers of public sector banks was surveyed to identify the factors contributing to operational disruptions and losses at branch levels. These were then consolidated to arrive at factors that critically influenced operational risk of banks. Nine factors were extracted from factor analysis that identified several variables related to people, processes, technology and external events as the major contributors of operational risk.

Global financial industry has undergone tremendous changes owing to intense competition, growing customer expectations, increased regulatory requirements and proliferation of financial innovations. Integration of services across sectors owing to financial convergence became common blurring the boundaries across financial markets. One such sector that has undergone significant transformation is the global banking system.

In the past, banking environment in India was regulated and was having a limited risk exposure. However, present day banking is exposed to numerous risks because of its increased level of operations and diversified services the banks offer. Liberalization of banking services has brought to the fore a plethora of financial innovations. These financial innovations in terms of products and services in the banking industry as well as financial convergence with other sectors have created huge business opportunities for banks. At the same time, they have made the banks vulnerable to many risks that were not known of earlier. More importantly, these risks have a contagion effect and are capable of bringing down the entire financial system down as was evident in the 2008 global financial crisis.

The growing complexity of banking transactions and those of allied sectors have led to an increased probability of failures from the operations perspective. Operational risk losses have led to the debacle of many financial institutions, the prominent ones ranging from The Barings Bank, The Enron, Allied Irish Bank and our own Global Trust Bank. The regulators are enforcing greater awareness among top management and compliance to operational risk management measures as specified by Basel committee from time to time. The Basel norms require banks to specifically focus on operational risk by identifying, measuring, evaluating, controlling and managing this all pervasive risk. This mandates a sound operational risk management framework in banks.

The present paper studies the critical factors influencing operational risk among the public sector banks based in Hyderabad. A sample of 100 branch managers of public sector banks was surveyed to identify the factors contributing to operational disruptions and losses at branch levels. These were then consolidated to arrive at factors that critically influenced operational risk of banks. Nine factors were extracted from factor analysis that identified several variables related to people, processes, technology and external events as the major contributors of operational risk.


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