Assessing the Operational Risk Management in Banks Based on Basel II Acord Methodology

Abstract
As every other business, there are a variety of risks in the banking industry, including operational risks. The Central Bank of the Islamic Republic of Iran, as the Basel Committee, has required computing and managing the operational risk for banks and financial institutions. Accordingly, the goal of this study is to evaluate the operational risk management in banks based on the Basel II accord methodology. This study is of case study type. That is to achieve the research purpose, the Bank Hekmat Iranian (merged with Bank Sepah) was chosen as a young bank in Iran. Due to access to the bank's financial statements, no sampling was used and all audited statements of this bank over 2011 to 2016 were selected as the statistical population of the study. Then, the operational risk of this bank was calculated using two "Basic Indicator" and "Standardized" approaches based on the Basel II accord methodology. Also, the Central Bank of the Islamic Republic of Iran directive were used to identify different groups of bank activity in Standardized method.
Descriptive statistics were used for data analysis. The results represent an ascending slope in operational risk in this bank over the research period. Due to the impact of the volume and the extent of banks' operations on the operating risk, this result could be due to an increase in the scope and volume of the operations in the bank during these years, which has directly affected the operational risk. This paper, while providing a relatively comprehensive and coherent literature about the operational risk, also provides details for calculating of this risk in banks. These details are based on the bank’s audited financial statements and can be used as a pattern to calculate operational risk in other banks.
Introduction
Every economic activity is exposed to risk. Because economic activities deal with the future and the future is always faced with risk and uncertainty. Credit and financial institutions are no exception. These institutions face a variety of risks, including credit risk, market risk and operational risk. Operational risk is the risk associated with the way a bank operates and manages its operations. Every risk arising from the way a bank operates is somehow indicative of operational risk. Operational risk factors can be within the organization (eg management and staff performance) or outside the organization (eg natural disasters).  The variety of factors that can lead to operational risk has made it difficult to measure this risk. Each bank's management must identify mechanisms for identifying and managing the risk and mobilize organizational culture to control and mitigate this risk. As described above, it is essential that banks and financial institutions are actively involved in the risk management process in order to monitor, manage and measure operational risk. They must have methods for quantifying operational risk so that they can calculate and control and mitigate this risk in their management scope. Therefore, the main question in this study is how much a bank's operational risk is according to the Basel II accord methodology.
Case study
This study is of case study type and the statistical population of the study is the data extracted from the audited financial statements of the Bank Hekmat Iranian (merged with Bank Sepah) during the research period. Since access to this data is feasible for the purpose of this study, sampling has not been used and the entire statistical population has been investigated.
Materials and Methods
Following Basel II (2006) and Central Bank of the Islamic Republic of Iran (2007) instructions, the “basic index” and the “standardized” approaches are used to calculate operational risk. In the “basic index” approach, a bank's operational risk per year equals a constant percentage of the bank's average earnings over the last three years. The “standardized” approach is similar to the “basic index” approach, except that it takes into account the fact that operational risk can vary between different segments of banks' operations. The “standardized” approach divides the bank's activities into eight working groups and considers for each working group a separate percentage of the average gross income as the operating risk for that group. Descriptive statistics were used to analyze and interpret the results.
Discussion and Results
The results showed that although the amount of operational risk in the “basic index” and the “standardized” approaches is slightly different and is greater in “standardized” approach than the “basic index” approach, but both methods show an increasing slope for the operational risk since 2014 to 2017. This means that the operating risk for Bank Hekmat Iranian has increased over these years.
Conclusion
The results can be interpreted as having a significant increase in the volume and scope of operations of the Bank Hekmat Iranian (merged with Bank Sepah) from 2014 to 2017, the risk associated with these operations has been increased too. Since the scope of operational risk is very wide and encompasses almost all aspects of bank activity, it is natural that as the scope of bank operations broadens, operating risk will increase. Of course, this increase is due to the expansion of the bank's operations and its upward trend and does not necessarily have a negative message for the bank. Because the higher the risk, the higher the return. Banks may rely on the output of the standardized approach to apply more stringent and maximum precautionary measures and consider larger precautionary reserves to cover the capital required for operational risk.