ABSTRACT
The study was done to assess the effect of operational risk management on organizational resilience in Nigeria whereby five banks in Lagos state were selected as a sample. The study had drawn 84 respondents randomly from the chosen five banks in the region, whereby the conclusions were generalized to all the banks in Nigeria. The sample was investigated using questionnaires and interview. It was found that operational risks policies, procedures and instruments are there in financial banks though to some extent they are not effectively managed. Also methods used to manage operational risks were not well implemented. Awareness of bankers on principles guiding operational risks was found to be minimal among them. The results revealed that most of the respondents proved that operation risk management in Nigerian financial institutions were found not well implemented. The study concluded that there were a lot of weaknesses in management of DOR including lack of strong risk management departments, weak rules and principles, unimplemented policies and biasness in the implementation of compensation. The study recommended a need for strong risk control departments, training and availability of insurance that are active in organizations. It is lastly suggesting areas for further studies to focus and asses the contribution of Nigerian financial organizations to the developments of their employees and to examine the effects of adopting the automated technologies among the banks in Nigeria.
CHAPTER ONE
INTRODUCTION
This Chapter introduces the study by presenting the background information to the problem, statement of the problem, purpose of the study, objective of the study, research questions, and significance of the study, delimitation of the study and definition of the key terms. This part introduces basic information about this research study.
1.1 Background Information
Nowadays, the management of operational risk by banks is a phenomenon that is widely accepted by most banking industries worldwide. This is substantiated by the fact that most of the banks are taking cognisance of the qualitative and quantitative criteria for operational risk management advocated by the Basel Committee on banking supervision (2003).
The financial and economic crisis has increased the preoccupations for the development of risk management over the last few years. As a result an appropriate terminology of the risk, sustained by modern and efficient methods and management instruments were developed. Guides, methodologies and standards have been drawn up with the purpose of formalizing the risk management implementation and the process, the organizational structure and the objectives of risk management (Ferguson, 2003). The guides and standards not only provide information on the process to be adopted in risk management, but also contain advice on how that process should be implemented successfully (Basel 1998). The standards formalize the operational risk management process in order to improve their effectiveness, but they don't guarantee it.
Once an organization decides to adopt a standard for risk management, it also has to deal with some practical considerations in order to implement it successfully by elaborating a plan for operational risk management implementation, designing an organizational structure for risk management. With a greater level of specificity, making risk management part of the enterprise culture, determining all risks categories of the organization, establishing a group of criteria and indicators that measure risk management effectiveness (Berger, 1997).
Operational risk is not a new risk in banking. In fact, it is that banks must manage, even before they make their first loan or execute their first trade. However, the idea that operational risk management is a discipline with its own management structure, tools and processes, much like credit or market risk, is new (PWC, 1997).
PWC (1997) defined operational risk as the risk of direct or indirect loss resulting from inadequate or failed internal processes, people, and systems or firm external events. Such events can lead to financial losses through error, fraud, fire or other disaster (Basel, 1998). Commercial Banks have explicitly dealt with risk throughout their existence. The very nature of banking activities requires these institutions to assume financial risks while providing innovative products to meet the needs of their clients. Institutions will continue to rely on gap management, credit scoring, and risk based capital requirements to cope with risk. However, new approaches must be developed and implemented to cope with the new financial products and services brought on by rapidly changing technology, the availability of real-time information, and increased competition bankers Magazine (1997).
According to Kimei (1994) emphasizes in the implementation of operational risk management system to meet the challenges of the twenty-first century. Specifically, management of these institutions will be compelled to identify their current risk exposure as well as potential exposure resulting from new business opportunities. These institutions will then be required to institute strategies to minimize these risks.
Commercial banks are in the risk business. The past decade has seen dramatic losses in the banking industry. Firms that had been performing well suddenly announced large losses due to credit exposures that turned sour, interest rate positions taken, massive frauds, or derivative exposures that may or may not have been assumed to hedge balance sheet risk. In response to this, commercial banks have almost universally embarked upon an upgrading of their operational risk management and control systems in order to survive in the new risk environment (Santomero, 1997).
Recent cases of theft of millions of money occurred in City, NBC Ltd, Stanbic and CRDB Bank demonstrated the significance of taking risk seriously by implementing effective internal controls. Barclays bank has shown the way by creating an independent unit responsible for managing operational risks. Operational Risk Manager heads the unit. This unit monitors and controls risk on daily basis. Despite of the relevant units, operational Risk manager is responsible for ensuring that the bank is not excessively exposed. This emphasizes the role of risk management.
The effect of risk materializing is widespread and is illustrated by documented failures in both centralized and decentralized economies (Saunders, 1994; Chijoriga, 1997; Honohan, 1997; Brownbridge, 1998; Basel, 1998 and Mitchell, 1999). In Africa, failure has been experienced in more than 40 countries including Ghana, Kenya, BukinaFarso, Burundi, Cameroon, United Republic of Congo, South Africa, Uganda, Nigeria, (Kimei, 1998). The tragedy is that this is a continuing trend encouraged by both internal and external factors.
As seen in the recent development in the southern American economies, bank failures lead to contraction of activities and decline in output in the economy. They normally lead to a multitude of losers such as;- uninsured depositors losing all or part of their deposits; insured depositor suffering temporary liquidity problems; firms losing financing and other bank benefits; Chief Executive Officers (CEOs) of the banks and bank employees losing their jobs or getting unwanted transfers and banks which have banking relations getting negative spill-over effect (Chijoriga, 1997).
Furthermore, bank failures impose substantial costs in the economy, and in particular on taxpayers, who have borne the burden of the central bank‟s losses and of reimbursing insured deposits (Brownbridge & Harvey, 1998). They also have an adverse effect on other local small financial institutions that have been managed in an honest and prudent manner (Brownbridge & Harvey, 1998). Bank failures damage the credibility of financial institutions throughout the financial sector, raising costs of deposits and forcing financial institutions to maintain high levels of excess liquidity as a precaution against bank runs (Brownbridge and Harvey, 1998).
Bank failure is caused by several factors identified by various researchers (Kathawala & Johnson, 1990; Banker, 1992; Banker, 1995; Santomero, 1995; Williams, 1995;
Chijoriga, 1997; Brownbridge and Harvey, 1998; Casson, 1998; Dowd, 1998; The Economist, 1998; Kimei, 1998 and Basel 1998). These are; breakdown of internal controls which lead to fraud and dishonesty, embezzlement, poor credit risk management, failure to cope with technological changes, poor and sluggish monetary and fiscal policies, bank deregulation/regulation policies and procedures, uncontrolled involvement of political connections to secure public sector deposits as well as heavy reliance on deposits from a few particular parastatals. Casson (1998; Dowd, 1998), reveals that, a number of recent banking problems arise from breakdowns of internal controls such as; Lack of adequate management oversight, accountability, and failure to develop strong control culture, absence or failure of key control structures and activities, inadequate communication of information between levels of management and inadequate or ineffective audit programs and monitoring activities.
Additionally, selective exposures such as credit cards, credit and financial risk are not the causes of insomnia today, in large part because banks have a good handle on how to control them. The big worries today and going forward are the risks that are harder to measure and predict operations compliance, litigation, reputation, and strategic risks and the interrelationships among them.
The management of these risks is typically informal, implicit, and often not as effective as we might like. We have already seen well-publicized evidence of just how much damage can be done to banks‟ shareholder value by exposure to these risks. Public reports on incidents such as at Barings and Daiwa suggest that they were due to operation failures (Ravi, 2000).
Cynthia (1997) further notes that system accidents were bound to happen. There are numerous other examples of systems failures and human errors that, much to the relief of the affected banks, have not been publicized. Nevertheless, they have caused serious internal problems, raised regulatory red flags, and resulted in sleepless nights for directors and bank management. Reducing the volatility of earnings resulting from risk exposures, risk management is the only path to follow. Risk management combines an expanded view of risk and a framework that builds risk management and control into everyday banking activities, at all levels of a bank.
George (2001) defines risk management as the act or practice of controlling risk. It includes risk planning, assessing risk areas, developing risk handling options, monitoring risks to determine how risks have changed, and documenting the overall risk management program. It calls for a structured yet flexible approach that constantly remaining scanning the constant but with adequate facilities to receive and give management feedback on changes and developments.
Basel (2001) recognizes that the exact approach for operational risk management chosen by an individual bank will depend on a range of factors, including its size and sophistication and the nature and complexity of its activities. However, despite these differences effective operational risk management has five components, a strong internal control culture (including, among other things, clear lines of responsibility and segregation of duties), effective internal reporting, and contingency planning are all crucial elements of an effective operational risk management framework for banks of any size and scope.
George (2001) explores that the key to successful risk management is early planning and aggressive execution. Good planning includes an organized, comprehensive, and iterative approach for identifying and assessing risk and risk handling options that are necessary to refine a program acquisition strategy. Now we can ask ourselves, do Nigeria Banks have operational risk management programs? How has operational risk management been integrated with business planning and operations? This study examines how commercial banks are managing operational risks. However, Banks should identify and assess the operational risk inherent in all material products, activities, processes and systems and its vulnerability to these risks. Banks should also ensure that before new products, activities, processes and Systems are introduced or undertaken, the operational risk inherent in them is Subject to adequate assessment procedures. While a number of techniques are evolving, operating risk remains the most difficult risk category to quantify. It would not be feasible now to expect banks to develop such measures.
However, the banks could systematically track and record frequency, severity and other information on individual loss events. Such a data could provide meaningful information for assessing the bank‟s exposure to operational risk and developing a policy to mitigate or to control that risk. On the other hand, this study assessed the effectiveness of the operational risk management on the commercial banks in Lagos state.
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