ICBC's Operational Risk Empirical Study

As a response to the frequently happened bank operational risk and its devastating impact to the financial field, The Basel Committee on Banking Supervision (BCBS) issued operational risk(OR) management in its"The New Basel Capital Accord"(Basel II) in July 26th,2004. In the new accord, OR is defined as"risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events", including legal risk but not strategic and reputational risk. Then OR, market risk and credit risk become three major risks which banking industry always face with and a large set of definitions, management methods and quantitative analysis'with respect to OR raised great concern in the global commercial banks. Basel II introduces three major methods to the measurement of OR: BIA, TSA and AMA, meanwhile based on these three measurement methods researchers in and abroad developed many sophisticated OR measurement approaches.The China Banking Regulatory Commission issued"the notice of CBRC on enhancing OR control"in 2005, which includes 13 guiding principles for bank deposit account management from aspects such as constructions of auditing system and regulatory framework, aimed to solve problems that business development of most domestic banks is impeded by the lack of ability in OR realization and management. ICBC published"OR management framework"in 2004, which has been implemented in the bank system as a part of"all-around risk management framework of ICBC". ICBC is considered to be the first bank which put OR management into its business schedule.Based on the review of research results of OR measurement from domestic and foreign commercial banks, this paper estimates the extent of OR in ICBC using empirical and norms analysis, particularly adopts revenue model which belongs to CAPM model. The purpose is mainly to test and evaluate OR of ICBC, and analysis the type of OR in state-controlled commercial banks which have similar situations like ICBC, and reveals deep-rooted reasons which caused these risks. Then we recommend some effective suggestions of OR control in accordance with the framework of Basel II and the financial market environment in China.The main content of this paper is logically divided into five chapters:Chapter I is Introduction. Briefed on the paper's research background, purpose and significance, this chapter introduces the literature and management practices of OR at home and abroad, and finally works out the specific research scheme. Chapter II is relevant theoretical analysis about OR. This chapter introduces the definition, classification and characteristics of OR, development of OR management stage, as well as OR measurement commonly used domestically and internationally. And this part set up the theoretical framework for the paper's in-depth study.Chapter III is empirical analysis of OR in ICBC. We collect data of the ICBC and Bank of China in this chapter, and make measurements and comparison of OR extent between the two banks using the revenue model of CAPM model. Besides, this part analysis OR data in depth. We conclude that the OR of ICBC is higher compared with Bank of China's. The OR of ICBC mainly concentrates in commercial banks, retail banks, payment and settlement and sales transactions. The types of OR in ICBC are performed in internal and external fraud, customer relationship, and implementation and delivery.Chapter IV analysis the reasons caused the OR in ICBC. Based on empirical analysis above, this part reveals the main reasons which caused the OR in ICBC from aspects as organizational structure, personnel, process design, and systems facilities using: the first is the property rights system deficiencies, followed by unreasonable organization structure, then missing operational risk management culture, and the last is inadequate operational system designs.Chapter V gives some solutions for the ICBC to prevent OR. From the effective control of OR perspective, this part proposes that ICBC should improve business from 6 aspects below: clearing property rights relationship, promoting the organizational structure of innovation, enhancing OR awareness in the bank, improving OR encouraging and restraint mechanisms, promoting self-product of technological innovation and product safety design, and the establishment of long-term OR management mechanisms.Based on the seriously study above, we have found the following important conclusions and recommendations:1. Using CAPM model we roughly estimate that the OR of ICBC is about 126 million, which is much higher. And we conclude that the profit of ICBC is influenced by its non-performing assets rate and macroeconomic environment, the affection of stock market is not obvious because the bank is just listed lately. Through the analysis of OR data of ICBC, we find that OR of ICBC mainly concentrated in commercial banks, retail banks, payment and settlement and sales transactions. Another notable case is non-business risks in the operation which has increased year by year. And the types of OR in ICBC focus on internal and external fraud, customer relationship, and implementation and delivery, because of policies and workplaces the OR has also increased in recent years.2. On the basis of empirical analysis, we found the main reason that led to OR in the ICBC focus on four areas: the first is congenitally deficient system of property rights, governance structure is irrational, poor management; and the second is unreasonable organizational structure, which leads to"commission - agent" chain is too long that moral risk flooded; the third is the building of OR management culture is leg, cultural management deficiencies, generally the bank management is lack of awareness of safe operation; the fouth is operational system is imperfect design that the conduction of new business and products is difficult.3. Based on the reason that caused the OR in the ICBC, we put forward 5 proposals from the effective control of operational risk perspective: first of all, on the basis of clear property rights, promote innovative organizational structure, improve OR management mechanism; second, strengthen cultural development in modern and enhance risk awareness as well as risk management awareness of various levels of the bank; third, make sure of clear risk management resposibilities, improve risk management incentive and restraint mechanism and penalties; fourth, promote technological innovation; strengthen the independence of safety design and safety management capacity design; fifth, establish bank OR databases and long-term OR management mechanism.