The Management of Operational Risk Through Appropriate Insurance Schemes

Contingent Client - Related Liability Risks One of the fastest growing and most intractable areas of operational loss exposure is that presented by contingent client-related liability. This relates to indirect responsibility for a client's business operations and products. Since major liability losses may bankrupt a client, plaintiffs will seek anyone connected with the client possessing sufficient funds to secure a financial settlement. Unfortunately, this is often a bank with whom the client had or has a relationship. These types of contingent liabilities may arise from a number of situations including. 1. Environmental Liability: Banks may incur substantial environmental liability when they become responsible for environmental damage or hazardous waste cleanup (i.e. an oil spill from a tanker for which the bank was a lender). This type of liability exposure is expanding globally at a tremendous rate as countries continue to enact ever more punitive environmental laws and regulations. 2. Product Liability: Product liability may occur when a client in which the bank has an equity position or financing interest is sued alleging negligence (i.e., class action suits against a pharmaceutical manufacturer). 3. Death and Bodily Injury : This liability may arise from an event involving a bank owned asset that is leased to or operated by others (i.e. commercial aircraft) or from an event involving a repossessed asset (i.e., fire at bank owned or controlled hotel). Therefore, as global environmental and product liability laws and regulations becomes more stringent and tort liability becomes more widespread, all Saudi banks will become increasingly more exposed to this type of operational risk both inside and outside the Kingdom. 2.3 Other Risks 2.3.1 Statutory and Regulatory Liability Globally, banking laws and regulations are becoming more complex, compliance more costly and time consuming, and the consequences of non-compliance (financial, legal, and reputation) more severe. In addition, some countries are increasingly applying criminal statuses to such essentially non-criminal areas as investment operations and cash management services. These liabilities may take three forms: 1. Financial Penalties : Within the Kingdom, violation of SAMA circulars and directives may result in substantial financial penalties being levied. Saudi banks operating outside the Kingdom are also subject to not only fines imposed by regulatory agencies, but may also find themselves responding to both civil and/or criminal charges which may carry financial penalties of such a magnitude as to cause a substantial impact on the balance sheet. 2. Restriction or Termination of Operations: Within Saudi Arabia, violation of SAMA rules and directives may lead to censure by the regulators and, in extreme cases, restriction of certain banking activities or total revocation of banking privileges within the Kingdom. This exposure is even more severe for Saudi banks operating outside the Kingdom. Even relatively minor technical violations of banking regulations may lead to the closure of major overseas branches. 3. Risk to Reputation: All banks fundamentally operate on the basis of trust. Therefore, publicity associated with statutory and regulatory infractions may act to undermine this trust with both customers and shareholders. While banks may be able to absorb both financial penalties and regulatory sanctions, they cannot absorb a major loss of customer and investor confidence. Therefore the maintenance of aggressive and highly pro-active compliance program by banks is becoming increasingly more critical as a major component in controlling the operational risks associated with regulatory and legal non-compliance.