The dissertation focuses on operational risk management in the world as well as in commercial banks in Vietnam such as the LienvietPostBank. The basic contents are the theories of operational risks, the role of this work, the effects of operational risk on the operations of a bank; the standard measuring for risk management and the taken steps. Also, this research carries out a study of the operational risk management at LienVietPostBank in order to have a practical point of view about these activities at the Vietnamese banks. By the applied research methods, the dissertation has showed the overall of advantages and disadvantages of the operational risk management in commercial banks. Moreover, this research fully applies the regulations of the Basel II agreement in the assessment of credit risk at Lien Viet Postbank. From that, this can be drawn out the practical measures on theory to improve the operations at the banks. 1. Research contributions This research has some important contributions. Theoretically, the dissertation has constituted a theoretical framework for examining and evaluating operational risk and its management. The dissertation also points out the underlying causes of these operations, and shows how to deal in terms of theory. More importantly, a part of the theory in the dissertation system is built on the basis of Basel II agreement on operational risk management at the banks. The dissertation provides a comprehensive overview about the operations of operational risk management as well as the views on these operations of the scholars in Vietnam and in the world. The most positive contribution of theoretical dissertation is that it considers and collects the processes and regulations as well as the measurement of operational risk management at the banks. The theoretical basis of the dissertation shall contribute to the banks to have useful facilities in the implementation of the risk management operations. In practice, during the implementation of this dissertation, we mainly use the actual data at LienVietPostBank that is one of the commercial banks that have implemented the operational risk management at their banks. Although they had many efforts, studied and learnt experience from other banks in the process of applying the operational risk management, they have not finished. In the research process, the dissertation evaluated the performance of operational risk management at the bank, indicating gained points as well as the existing points of the bank. Especially, through the study of Basel II regulations, the dissertation measured and quantified specifically the operational risk of Lien Viet Postbank by the underlying index methodology and standardized method. This is an important basis for banks to review their performance, to find out more effective measures of operational risk management in the future. In addition to analyzing the operating situation as well as quantifying a number of operational risks in the bank, this dissertation also offers practical solutions for risk management operations at LienVietPostBank, specifically, in which it is required to establish the budget for precautions of operational risk at the bank. In resume, this research has contributed to the theoretical as well as the practical aspects for the operations of operational risk management in LienvietPostBank. To be able to build a procedure as well as a fully worked-out operational risk management system, it takes a lot of time, effort and the special concern from bank leadership on this issue. 2. Research limits and perspectives The main limit of this research is that the dissertation has not quantified the operational risk at LienVietPostBank according to the AMA advanced methods. The reason is that the bank did not meet the requirements of this method to quantify. In addition, the solutions of the dissertation are mainly oriented and theoretical, although there are evident as well as specific models for improving risk management; the dissertation has not provided the specific methods for solving this problem. Also, this dissertation has not showed the relationship between the operational risk and the other factors of the risk in the banking system. Finally, the research was limited in a research field of LienVietPostBank. In the future, researching on risk management in general and operational risk management in particular will be an issue that has many matters to be dealt with. The issue that researches need to focus on is to quantify specific operational risk in banks under the Basel II methodology (including the AMA method). In addition, the analysis of the actual relationship between the operational risk and other types of risks in the banking system is still an issue that needs more research to clarify. It is necessary to indicate the influence as well as the impact of operational risk on other types of risk, and vice versa. Another important part that future studies should focus on is to draw out specific solutions for operational risk management, which can be quantified. Although this is still a relatively new issue in the banking sector, operational risk management is very important. Researching on the trends and effects of operational risk management will be the basis for improving risk management at banks in the future.
i ACKNOWLEDGEMENTS I would like to express my thanks to the teachers of the Vietnam University of Commerce, for their kind assistance and creating every favourable condition for me to finalize this report. Particularly, I owe to much Mr Dr Vu Manh Chien – my tutor at University for spending much time and energy in guiding me through the research and helping me complete this report. It is a great pleasure to thank all collogues at LienVietPostBank who helped me write my dissertation successfully, who created favourable conditions for me to complete this internship. Many thanks to my close friends for their true care and assistance in sharing knowledge during the education and implementation of this dissertation. Finally, I would like to show my gratitude to my family for so much care, worry about me all the three years studying at the university. ii Table of contents ACKNOWLEDGEMENTS ii List of tables v INTRODUCTION 1 1. Research context 1 2. Reasons of subject choice 1 3. Research objectives 2 4. Research object and limits 3 5. Dissertation structure 3 CHAPTER 1: THEORETICAL FRAMEWORK ON OPERATIONAL RISK MANAGEMENT IN BANKING 4 1. Operational risk in banking sector 4 1.1. Definition of operational risk 4 1.2. Classification of operational risks 4 1.3. Consequences of operation risk 6 2. Operational risk management in the bank 6 2.1. Operational risk management 6 2.1.1. Conception of risk management 6 2.1.2. Conception of operational risk management 8 2.2. Role of operational risk management 8 2.3. Literature review on operational risk management 10 2.4. Operational risk measurement according Basel II 12 2.5. Operational risk management according Basel II 14 3. Content of operational risk management in commercial banks 16 3.1. Identifying operational risk 16 3.2. Operational risk measurement 17 3.3. Developing and implementing operational risk management 18 3.4. Reporting operational risks 18 3.5. Controlling operational risks 18 3.6. Allocating capital to operational risk management 19 CHAPTER 2: RESEARCH METHODOLOGY 20 iii 1. Introduction of research field of LienVietPostBank 20 1.1. Brief outline and history 20 1.2. Scope of business 20 1.3. Key indicators 21 1.4. Bank’s strategic position: SWOT Analysis 22 2. Collecting and processing data 25 2.1. Phases of research 25 2.2. Secondary data collection method 25 2.3. Primary data collection method: 26 2.4. Processing data 26 CHAPTER 3: OPERATIONAL RISK MANAGEMENT AT LIENVIETPOSTBANK 27 1. Identifying the factors resulting operational risks 27 1.1. Cause related to personnel 27 1.2. Cause of IT errors 27 1.3. Cause by procedures, regulations 28 1.4. Other factors 28 2. Quantifying operational risk of LienvietPostBank according to Basel II 28 2.1. Quantifying by the basic approach 28 2.2. Quantifying by the standardized approach 30 3. Analyzing the operational risk management at LienvietPostBank 32 3.1 Legal framework for operational risk management 32 3.2. Actual operational risk management at LienvietPostBank 35 3.2.1. Applied method 35 3.2.2. Actual operational risk management at Lien Viet Postbank 37 4. Recommendations for LienvietPostBank’s operational risk management 41 CONCLUSION 45 1. Research contributions 45 2. Research limits and perspectives 46 BIBLIOGRAPHY 47 iv List of tables Table 1: Key financial indicators of Lien Viet Postbank 21 Figure 1: Phases of research 25 Table 2: Financial report of LienVietPostBank from 2010- 2012 29 Table 3: Profit by each field of the LienVietPostBank 31 Table 4: Provision for operational risks according to the standardized approach 32 v INTRODUCTION 1. Research context International integration opens opportunities for the Vietnamese banking sector to approach the international financial level and standards. However, these tendencies that imply global competitions, demand that Vietnamese banks must meet the requirements of business management in general and of risk management in particular at international standards. Recently, since more importance has been attached by Vietnamese commercial banks on risk management, including credit risk, liquidation risk, interest rate risk, etc., up to now a fairly good foundation in terms of both knowledge and resources has been built in this topic. Nevertheless, operational risk management has only been being cared for, studied, and carried out over the past few years in our country. In general, operational risks are related to many elements such as human beings, internal systems, procedures and external events. These are very diverse and constantly changeable, hence operational risks usually occur in almost all important banking operations. Researchers in several advanced nations have calculated that the effect of operational risks from normal banks accounts for 10% of operating profit. In addition, operational risks also have considerable impact on the bank’s reputation. In the current development trend, operational risks are a big problem due to the operating environment is becoming more and more complex, ever-growing illegal acts under the conditions of international integration and work pressure, which entail higher and higher performance as well as the loyalty of employees and the whole-heartedness of the management; the more and more dependence on technology, along with the ever-increasing rate and volume of transactions are also the elements that bring an increase in operational risks. So, in reality, operational risk management is ever more pressing under the conditions for international integration of Vietnamese commercial banks. 2. Reasons of subject choice I choose the subject on operational risk management is for a number of reasons: Firstly, business operations are becoming more and more complex; the competition pressures between banks are growing, together with the increasing criticality of risks. Subject to each specific way of approaching, banking business risks can be divided into different types, however, under the most common classification, according to Basel Commission, banking risks involve three basic types: Credit risk; market credit; and operational risk. Vietnam commercial banks are gradually approaching such concepts and have step by step managed these types of risks according to normal banking practice. Secondly, there have been not many research on operational risk at commercial banks published in Vietnam qualified for application to or serving as grounds for formulating or completing the commercial bank management procedures. One of the very few most recent relevant works as such was the Master’s Dissertation on “Operational risk management at Vietnam commercial banks” by author Nguyen Hoai Linh, Economics University, Vietnam National University, Hanoi, which provides an overview of operational risk management at Vietnam commercial banks, some assessments on the advantages, shortcomings of the operation 1 risk management that the author has conducted researches on the banking industry as a whole, from that to propose a number of solutions and suggestions thereof. Thirdly, studies in Vietnamese on this subject are often characterized by some orientations, recommendations at macro level, rather than going down into detail on the situation of Vietnamese commercial banks. Specifically, the solutions as proposed by the work above include: To improve the effectiveness, performance of the legal framework, financial institution in operational risk management at Vietnam commercial banks; to enhance the internal management capacity of commercial banks; to restrict the banking organizational structure’; to strengthen the financial ability…, are the targets every bank wishes to achieve. Nonetheless, the contents for implementing industrial have not yet been detailed by the author to reach such targets. This is also the general situation of research works at the present time, when there are too many solutions served as “guidelines” whilst lacking the detailed contents which can enable the researching entity to carry out the solutions. Thus, the author has realized that there should be further research works which are more practical and associated with specific commercial banks. Fourthly, from many years’ experience practicing at LienvietBank, I have had the chance of working in Risk Management Division of the bank, in specifying on the operational risk. I have found that the operational risk management there needs to be further improved in such contents as the procedure for operating risk management for credit, capital trading, fund operations, etc. Therefore, it is not only the actual situation of theoretical studies on this matter that is lacking a lot of important contents and should be elucidated but also even Vietnam commercial banks in general and Lien Viet Joint-Stock Bank in particular still need to have studies or researches which are practical and immediately applicable to the management process. Under such practical conditions and wishing to apply the theories his has learned from the postgraduate program at Vietnam University of Commerce, I have decided to choose “Operational risk management at Lien Viet Joint-Stock Bank” as the subject of this dissertation. The research questions are formulated as following: - How can a bank quantify its operational risk based? - Which causes lead to operational risk in the bank? - Which factors affect the operational risk management activities of the bank? - Which methods to measure and evaluate operational risks in the bank? And what are their performances? 3. Research objectives This research aims at the following specific objectives: - Complete the basic theoretical system of risk management and operational risk management based on meta-analysis of local and international researches; - In-depth research on the theory system and the theories of operational risk management at commercial banks based on analysis of the theoretical research specialized in banking – finance and actual operations of Vietnamese commercial banks. - Synthesis and presentation of operational risk management models at commercial banks which have been developed and applied globally; assessment of applicability at Vietnamese commercial banks; 2 - Research on operational risk management applied at Lien Viet Commercial Joint Stock Bank including: define responsibilities and authorities of individuals and units related to operational risk management ; identify the costs, losses that can occur from the operation - Evaluate the effectiveness, advantages and limitations of the operational risk management at Lien Viet Commercial Joint Stock Bank in recent years; - Propose solutions to complete the operational risk management at Lien Viet Commercial Joint Stock Bank. - Change the perceptions of bank leaders in a positive way about the role of operational risk management at commercial banks 4. Research object and limits - Research object: operational risk management in banking - Research field: Lien Viet Commercial Joint Stock Bank - Documental research: document on operational risk management in Lien Viet Commercial Joint Stock Bank from 2010 to 2013; annual reports, thematic reports on operational risk - Practical limit: observation and practical work at the bank - Interview: interview with manager, staff in the risk management department, the people directly involved in operational risk management 5. Dissertation structure This dissertation is structured in three chapters as follows: • Chapter 1: Theoretical framework on operational risk management in banking • Chapter 2: Research methodology • Chapter 3: Operational risk management at LienVietPostBank 3 CHAPTER 1: THEORETICAL FRAMEWORK ON OPERATIONAL RISK MANAGEMENT IN BANKING 1. Operational risk in banking sector 1.1. Definition of operational risk The most popular definition of operational risk appeared for the first time in Robert Morris Associates et al. (1999), where operational risks were defined as direct or indirect damages from the insufficient or unsuccessful internal procedures by human and system, or external events. Initially, this definition was adopted by Basel Committee; nevertheless reference of indirect damages was excluded as measurement was very difficult. Therefore, operational risks were defined by Basel (2004) as consequences likely to occur from the insufficient or unsuccessful internal procedures by human and system, or external events. However, this definition described the definition as “broadly as completely useless” or ignored basic business risks (Herring, 2002; Turing, 2003). Vinella and Jin (2005) gave another definition of operational risks. They defined operational risks as “risks in which operation cannot meet one or more objects of operation performance, the causes may be personnel, technology, procedures, information and support for infrastructure business activities”. They believed that the definition by Basel was a special case of their definition when the failure to meet the operation performance object constituted a loss of money. Once more time, there was no specific reference to the role of the external elements in this definition. To date, however, the definition by Basel has still been applied at major banks or credit institutions as a standard definition of operational risks. Operational risks arise from ineffectiveness of information systems, from technical errors, from internal control errors, from unintended events or other operational issues that can lead to unexpected loss or reputation issues. The scope and duration of operational risk is very large, the risk can occur at any time during the operation of the bank. According to Basel II, operational risk is the risk of direct or indirect loss due to inadequacy or failure of the processes, people and internal systems, or from external events. Operational risk includes legal risk, but excludes strategic risk and reputation risk. Thus, the operational risk is caused by following factors: processes, people, systems, external events and other issues. These factors are shown as follows: processes, people, systems, and external factors These factors affect all business operations of the bank. Therefore operational risk exists in all of the services and business operations of the bank, which is why there are a lot of issues related to operational risks such as: business strategy, policies, operational procedures, organization, operations, operational support, human resources, infrastructure, information technology, control measures and the audit work. 1.2. Classification of operational risks In 2006, Basel Committee for banking supervision announced a literature revue of internal tools for measuring capital and capital standards, known as Basel II Capital Accord, herein under referred to as Basel II (2006). Basel II was intended to introduce a new approach to 4 risks in the banking industry. The new regulations combined requirements for minimum capital with market assessment, supervision and standards to pose a procedure for better managing risks in order to minimize the overall risks of organization. Basel II employs to a larger extent the risk assessments provided by banks’ internal systems. Basel II definitions of kinds of risks together with core business areas as found in a banking organization as follows (Unchiaşu, 2009): • Credit risk is defined as risks related to contact with customer as individual borrower or partners and level of investment portfolio; • Operation risks are damage risks resulted from insufficient or unsuccessful internal procedures for the reasons of personnel and systems or external events. Operation risks involve legal risks, referred to as legal loss or damage resulted from wrong action by the bank or its employees, equivocal with regard to requirements and legal effects, ineffective in relation with the national legal system; • Market risks is defined as risks of losing potential finance as a result from any adverse change of the market such as interest rates, exchange rates; • Interest rate risks involve all interest rate values of banks and refer to all adjustments of relevant due interest rate data; • Liquidation risks are risks in which: banks won’t receive assets that meet all borrowers’ obligations at reasonable expenses; • Reputation risks: reputation is an invaluable, invisible asset but of high value; negative public opinions constitute considerable risks which result in the loss of supporting resources or customers; • Strategy risks are possible negative effect on the revenue and capital of banks resulted from erroneous, inadequate decisions on business and development strategies and insufficient human resources to meet strategic objectives and with changes in the industry. Also, based on the factors affecting operational risk or in other words, based on the causes of operational risk, operational risk can be divided into the following types: - Risk caused by internal issues o Risk caused by bank employees o Risk caused by regulations, business process: o Risk from support system o Risk from other support systems - Risk caused by external issues: o Risk caused by fraud, theft or crime of external objects such as: theft, robbery, forgery of papers, forgery of checks o Risks caused by external events or natural disaster (earthquakes, floods, hurricanes, etc.) causing damage to the business operations of the bank. o Risk caused by changes in documents, government regulations and relevant 5 [...]... Identifying operational risks, including the management of this type of risks at LienvietPostBank; • Quantifying operational risk of LienvietPostBank according to Basel II • Analyzing the operational risk management at LienvietPostBank • Finally, discussions on operational risk management of LienvietPostBank The obtained results will be presented in the next part of this dissertation 26 CHAPTER 3: OPERATIONAL. .. Website: www.lienvietbank.net License No.: 91/GP-NHNN issued by State Bank of Vietnam on 28/03/2009 LienViet Joint Stock Commercial Bank (LienVietPostBank), its forerunner: LienVietBank, was established under License for Establishment and Operation No 91/GPNHNN dated 28/03/2009 of Governor of the State Bank of Vietnam In 2012, with the investment of Vietnam Post and Telecom Corporation in LienVietPostBank... LienVietPostBank by the value of Vietnam Postal Savings Services Company (VPSC) and cash, LienVietPostBank was permitted by the Prime Minister and Governor of the State Bank of Vietnam to rename LienViet Joint Stock Commercial Bank Along with this, Vietnam Post and Telecom Corporation became the biggest shareholder of LienVietPostBank The shareholders as founders of LienVietPostBank include Him Lam Joint... improve the performance of operation risk management in LienVietPostBank 2.2 Secondary data collection method The secondary data includes documents, books, articles on bank operational risk management; annual financial statements and reports on operational risk management status of Lien Viet Bank; presentations, discussions in seminars specialized in operational risk management from 2010 to 2013 The objective... billion dong, LienVietPostBank is one among the ten biggest commercial banks in Vietnam Shareholders and strategic partners of LienVietPostBank include major financial-banking institutions operating in Vietnam and abroad such as Vietnam Bank for Agriculture and Rural Development (Agribank), Wells Fargo (USA), Credit Suisse (Switzerland), Oracle Financial Services Software Limited… LienVietPostBank has oriented... OPERATIONAL RISK MANAGEMENT AT LIENVIETPOSTBANK 1 Identifying the factors resulting operational risks Like in other areas of the economy, banking operations have to face certain difficulties, including operational risks This state has happened and reported in most commercial banks of Vietnam, including LienvietPostBank During his internship at this bank, the author carried out interviews with the bank s... Testing Operational Risk began by an observation: the banks always face with three major types of risk: credit risk, operational risk, market risk and credit risk; people always think credit risk is the biggest concern of the banks Then, the author pointed out: 80% of the credit risks are actually operational risks In fact, an effective operational risk management system can even helps the bank to... article of operational risk provision Therefore, the Bank has not ensured the criterion of operational risk management set by Basel II Agreement which has come into reality since 2007 In the bank s articles only exists provision for credit risk We can temporarily ignore requirements of Basel II about the operational risk provision, but if LienVietPostBank got operational risks and credit risks at the... the important documents about operational risk, risk management and about LienVietPostBank Hence, all the bank s recent annual reports and financial reports including ones related to operational risk management have been explored and analyzed To collect more information on the current research, we also studied some other documents related to operational risk management in Vietnamese organization 25 2.3... adhering to banking procedures Based on analysis of the nature and operational risk management, Schmitz (2001) made a list of issues relating to the growing interest in the requirement for operational risk management He also differentiated the strengths of operational risk management, with the importance of operational risk management: the attention to paying money for operational risk management is . sector, in means of transport, in energy industry, banking, education, and almost all activities. In some areas, in order to increase sensitivity to. activities: The consequences banks have to increase may include failure to make payment as per customer request or payments to the wrong beneficiaries. ✓ For