To encourage banks to focus attention on assessment of operational risk on products and processes, regulators should be aware of new products, improvements in management information systems and computing technology that have opened the way for improved operational risk measurement and  BIS Review 88/2005  1  management. In the next few years, financial institutions and their regulators will continue to develop various approaches for operational risk management and capital budgeting techniques. 5. Let me focus on some key areas of operational risks and regulatory responsibility in the interest of financial system stability. 6. Sound management of operational risk is particularly important in payment, clearing, and settlement systems as such risks can spread across systemically. All owners and operators of payments, clearing and settlement systems face operational risks but the degree may vary from system to system and from country to country. Operational problems in a payment, clearing, and settlement system may impede the control of, or even exacerbate, other types of risk such as market, liquidity, or credit risk in an unanticipated way that could pose a systemic risk, resulting in participants incurring significant losses. It may not stop there. Payment and settlement related operational risks could filter into businesses of banks’ clients, governments and the country’s international correspondents as well. This aspect of banking operations was ignored for many years and it is fairly recently that regulators and banks started addressing payment and settlement related operational risks.

The regulators should be mindful of high operational risks in these businesses and bring them to the attention of banks. 9. Uncertainties, regulatory challenges in promoting banks In a lighter vein, operational risks can be categorized into two, i.e. man-made risks (mistakes, faulty models, frauds, terrorism, wars etc.,) and god-made risks (earthquakes, floods, Tsunami disasters, electrical blackouts, telecom interruptions etc.) Some of these are well known and banks handle them in their own ways. Complexity of the assessment process and required changes to it, uncertainty in the implementation date of Basel Accord, the US and some European banks’ attitude towards implementing the Accord, variability in data reporting are a few factors that have created uncertainties in banks as well as regulators’ minds. I believe that these challenges can be overcome if banks can be encouraged to adopt a systematic approach as set out in Basle II. First and foremost, regulators have to get banks to commit to a risk mitigation cycle which consists of (a) risk diagnosis (i.e. prioritization of objectives, documentation review/meetings and building up of a risk control culture profile); (b) risk identification within a framework; (c) risk assessment and preparation of action plan; and (d) risk reporting. 10. The choice of the approach/models banks wish to adopt may have significant implications. Score card, loss distributions and internet modeling are some of the popular risk models. All of them have implementation challenges, in particular, skills shortage, non-availability of reliable data and suitable IT systems.