The Management of Operational Risk Through Appropriate Insurance Schemes

Select and Implement Risk Management Techniques: Operational risks are most effectively controlled through integration of various risk control methods. The incidence of fraud may be controlled through rigorous training of personnel, fraud prevention and detection program, effective operational management, and internal auditing and, finally, through the Bankers Blanket Bond (BBB) and Financial Institution Bond (FIB). Litigation risks associated with professional liability may be dealt with through careful product risk analysis and training of personnel prior to implementation of sale or marketing programs, close attention to contractual indemnities with customers and, finally through a program of Professional Indemnity Insurance. All of these strategies involve the careful analysis, selection, integration, and management of risk assumption, risk avoidance, control and transfer tools (including insurance) based on a thorough knowledge of the bank's business lines and operational risk exposures. 1.3 Managing and Evaluating Operational Risk Management: The management of operational risk is one of the major functions of the Board of Directors of any bank. Therefore, it is incumbent upon the Board to ensure that operational risks are being properly identified, analyzed, controlled, and managed. This should be done by the Board through a periodic review of the performance of operational risk management within the bank in much the same manner as it reviews the effectiveness of financial and market risk management activities. On an annual basis the Board of Directors, or the Audit Committee, should receive the results of an internal review of the Risk Management Function. Furthermore at least once every 5 years, or more frequently if appropriate, an independent review of risk management activity must be conducted, and reported to the Board. 2. Elements of Operational Risk 2.1 Criminal Risk Historically, the single largest area of operational risk within the Saudi banks has been that associated with criminal activities. In a survey conducted by the Agency covering all the claims filed by Saudi Bank with insurers there for financial losses attributable to fraud end other criminal activities either on the part of employees or third-parties. These represent 100% of all operational losses claimed under existing insurance coverage. 2.1.1 Fraud In 1993, the accounting firm KPMG conducted a fraud survey of six countries-the United States, Canada, Australia, the Netherlands, Ireland, and Bermuda. This study found that, on average, approximately 80% of all frauds committed were perpetrated by employees, 60% by non-managerial personnel and 20% by managers. In all of the countries surveyed, misappropriation of cash was the most common form of employee fraud. This would appear to fit the situation currently being encountered by Saudi banks, since most employee fraud losses have come from the theft of cash and or travelers checks from. branches and ATMs. Consistent with international trends Fraud currently represents the single largest area of operational loss within the Kingdom's banking system. During the past five years, approximately 85% of all operational losses sustained by banks in the Kingdom involved employee dishonesty. Recovery of funds lost due to fraud (particularly cash) is, at best, difficult and in many cases simply impossible. This highlights the fact that programs designed to prevent fraud are significantly more effective and less expensive than are attempts to recover the funds once stolen.