Waking the Sleeping Giant

Within the banking sector operational risk is often perceived to be a less important risk than financial risks such as market or credit risk. Such a view is typically reinforced by the observation that banks are in the business of taking these financial risks and must lend large amounts of money and/or take significant market positions if they are to make an acceptable profit for their owners. Events such as the global financial crisis would also seem to reinforce this view of the pre-eminence of financial risks. Taken at face value the crisis might appear to have been caused by a combination of excessive lending, leverage and derivatives trading - activities which fall with the realm of financial risk. Yet deeper investigations into the crisis have revealed that other more complex forces were at work, forces, such as failures in people, process and systems which have more in common with the field of operational risk. In this paper we argue that banks must do more to wake the sleeping giant of operational risk management in their activities. We demonstrate how operational risk related failures in people, processes and systems lay at the heart of the global financial crisis, leading to disastrous consequences not only for individual banks, but also for the financial sector as a whole and the domestic economies that are supported by it. We also highlight three key barriers that we believe are preventing the discipline of operational risk management from reaching its full potential in the banking sector. Finally we identify a number of themes that we believe should be embraced by banks and their regulators to help overcome the three barriers and enhance the management of operational risk across the sector.