Operational risk is the risk that occurs due to the human error, systematic error, and procedural error. The operational risk is associated with the company’s priority and the decision about the functionality of organization. Precisely, it occurs due to the errors in operations made by the company.
First risk to be considered here is the debt risk of the organization, which is at around 1600% for the organization, this is considered as an operational risk because the payments of interests for that amount of risk creates a heavy liability on the operations of the organization. This can be further explained by the effect that as the costs increase heavily, organization will be forced to cut costs in other areas such as production, and work force. This we can observe in the case study. The debt in terms of our current task creates a heavy risk on the portfolio of the organization.
In the case of Korea First Bank, the main reason for its crisis was human error. The human risk is the risk which arises due to the human error, whether it is an unconscious mistake or a wrong decisionor analysis.
In the crisis of 1997-98, KFB had lent W5000 billion to Hanbo Construction Company ignoring the fact that the government restricted lending too much money to chaebol. Actually, by doing this, KFB made a significant human decision error without looking at the insights of the outcomes of the decision. KBF took this risk just for the sake of the relationship with Hanbo by going beyond its lending limitbut, soon suffered from the outcomes. However, later some executives were sued for this negligence but this crisis greatly affected the reputation and performance of the company.
The procedural error arises when there is flaw or unorganized steps in procedures to achieve any goal.Also, the company had not gone for the market research before making the decision of lending and blindly trusted Hanbo which also shows the inability of the management of the bank. The management of the company did not go through the proper executives meeting sessions and analysis of the future outcomes before making the decision.
The previous approaches to calculatingoperational risk capital was; Basic Indicator Approach (BIA), Standardized Approach (STA), and Advance Measurement Approach (AMA). But, there is an advance and consistent approach to calculate the operational risk capital that is Standardized Measurement Approach (SMA).
We can easily use Standardized Measurement Approach (SMA) to calculate the operational risk capital provided sufficient data for this. In SMA approach, we are required to have two main components; Business Indicator Component (BIC) and Loss Multiplier (LM). The BIC is derived from Business Indicator, and loss multiplier is sought out from the bank specified historical operational losses. Then we multiply the above two components to get the capital for operational risk.Having the highest explanatory power, Business Indicator has been chosen as the risk indicator for the SMA………….
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