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Managing Operational Risk in Payment, Clearing, and Settlement Systems

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  • Kim McPhail

Abstract

Awareness of operational risk has increased greatly in recent years, both at individual financial institutions and for payment, clearing, and settlement systems (PCSS). PCSS consist of networks of interconnected elements (i.e., central operators, participants, and settlement agents); operational problems at any one of the key elements have the potential to disrupt the system as a whole and negatively affect financial stability. The author describes the key features of systemically important PCSS in Canada and the oversight role of the Bank of Canada with respect to those systems. She also describes one approach that could be used to assess and manage operational risk in Canadian PCSS. This approach relies on a consistent definition of operational risk that can be applied across all elements of a PCSS. It uses a recent methodology adapted from the management of operational risk at individual financial institutions. This methodology, called the loss-distribution approach, assesses risk in terms of the potential outcomes of operational events owing to certain risk factors (such as systems problems, human error, process problems, and external events), their likelihood, and their frequency. Once operational risk databases are developed that record the frequency and severity of operational events, it will be possible to estimate parts of the loss distributions for PCSS. In the meantime, qualitative analysis provided by operations experts associated with the various elements of PCSS will be important for judging the potential impact and frequency of events. In a changing financial environment, it is hoped that this methodology could be used to supplement core aspects of operational risk management, such as sound corporate governance, internal controls, policies and procedures, knowledgeable people, and robust contingency plans.

Suggested Citation

  • Kim McPhail, 2003. "Managing Operational Risk in Payment, Clearing, and Settlement Systems," Staff Working Papers 03-2, Bank of Canada.
  • Handle: RePEc:bca:bocawp:03-2
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    References listed on IDEAS

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    1. Hussain, Amanat, 2000. "Managing Operational Risk in Financial Markets," Elsevier Monographs, Elsevier, edition 1, number 9780750647328.
    2. Freedman, C., 1999. "The Regulation of Central Securities Depositories and the Linkages between CSDs and Large-Value Payment Systems," Technical Reports 87, Bank of Canada.
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    Cited by:

    1. Gregor Heinrich, 2006. "Riesgo operacional, pagos, sistemas de pago y aplicación de Basilea II en América Latina: evolución más reciente," Boletín, Centro de Estudios Monetarios Latinoamericanos, vol. 0(4), pages 191-204, Octubre-d.
    2. Richard J. Sullivan, 2007. "Risk management and nonbank participation in the U.S. retail payments system," Economic Review, Federal Reserve Bank of Kansas City, issue Q II, pages 5-40.
    3. Ripatti, Kirsi, 2004. "Central counterparty clearing : constructing a framework for evaluation of risks and benefits," Research Discussion Papers 30/2004, Bank of Finland.
    4. anonymous, 2007. "Nonbanks and risk in retail payments," Payments System Research Working Paper PSR WP 07-02, Federal Reserve Bank of Kansas City.
    5. Richard J. Sullivan, 2006. "The supervisory framework surrounding nonbank participation in the U.S. retail payments system : an overview," Payments System Research Working Paper PSR WP 04-03, Federal Reserve Bank of Kansas City.

    More about this item

    Keywords

    Financial institutions; Payments; clearing and settlements systems;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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