Comprehensive operational risk management will generally involve all three pillars. Pillar 2 was added because of the need for efficient supervision and the lack of it in Basel I, relating to the assessment of the adequacy of a bank's internal capital.
Under pillar 2, banks are required to assess the adequacy of domestic capital to cover all risks they may face in the course of their operations.
The supervisor is responsible for verifying that the bank uses appropriate assessment approaches and covers all associated risks. Pillar 3 aims to ensure market discipline by making the disclosure of relevant market information mandatory.This is done to ensure that users of financial information receive the relevant information to make informed business decisions and ensure market discipline. However, many now collect data on operating losses (for example, due to system failure or fraud) and use it to model operational risk and calculate a capital reserve against future operating losses. Broader trends, such as globalization, the expansion of the Internet and the rise of social networks, as well as the growing demand for greater corporate responsibility around the world, reinforce the need for adequate risk management. Operational risk is the risk of losses caused by faulty or failed processes, policies, systems, or events that interrupt business operations.
The operational risk management framework must include frameworks for identifying, measuring, monitoring, reporting, controlling and mitigating operational risk. The Basel II definition of operational risk excludes, for example, strategic risk, that is, the risk that a loss will result from a poor strategic business decision. The Basel Committee on Banking Supervision (BCBS) has proposed the standardized measurement approach (SMA) as a method for evaluating operational risk to replace all existing approaches, including AMA. As MFIs become decentralized and offer a wider range of financial products and alternative delivery channels, operational risks are multiplying and it is becoming increasingly important to manage them effectively.
For both militaries and companies around the world, operational risk management is an effective process for conserving resources in advance. The Basel Committee recognizes that operational risk is a term that has several meanings and, therefore, for internal purposes, banks can adopt their own definitions of operational risk, provided that the minimum elements of the Committee's definition are included. The operational risk charge is new and controversial because it's difficult to define, let alone quantify, operational risk. These reasons underscore the growing interest of banks and supervisors in identifying and measuring operational risk.
Employee errors, criminal activities, such as fraud, and physical events are some of the factors that can trigger operational risk. The standardized approach is suitable for banks with a lower trading volume and a simpler control structure. For example, reputational risk (damage to an organization due to the loss of its reputation or prestige) can arise as a consequence (or impact) of operational failures, as well as other events.
