Risk Management and Value Creation in ... - Arabictrader.com

Capital Structure in Banks 197
credit and market risk 292 used so far and tries to measure the generally much
larger impact of event (or discontinuous) risks on a bank’s cash flows and
value. 293 However, it (mostly) does not include the (indirect) impact on the
entire organization (and its employees) and the bank’s overall liquidity. 294
In order to clarify the broad definition given previously, we split operational
risk into two subcategories of risk, which will be discussed in the light
of its measurement and management in turn below:
■
■
Event risk is the risk that losses to the bank are caused by rare
events 295 such as a major systems failure, 296 process and control failures
(e.g., errors and omissions), 297 fraud, 298 legal risk, 299 and external
disruption (e.g., fire or other catastrophes).
300, 301
Business risk is the risk that the bank will experience losses through
unexpected changes in either (future) revenues (affected by volume
and price) or (fixed) costs that are not due to credit or market risk, 302
but rather driven by fundamental (and unexpected) changes in the
bank’s competitive environment 303 (e.g., price wars, new competitors,
304 changes in regulation, etc.).
292 This book will not, however, cover the measurement and management of insurance
risk.
293 See Damodaran (1997), p. 777. All recent big losses to banks basically stem from
event risks and were already summarized in the Wheel of Misfortune (see Chapter 3).
294 Due to or leading to bank runs, see Cooper (1999), p. 7.
295 For a list of descriptions/definitions of such events see Lam and Cameron (1999),
p. 85, Table 2.
296 Losses due to failed management information systems, communication, or computer
systems.
297 Unintentional losses due to human error or noncompliance with established business
guidelines.
298 Losses due to employee or third-party theft, mismanagement, or deceit.
299 Cost of legal fees, fines, and lost settlements resulting from legal actions and lawsuits
or fines, and opportunity costs resulting from regulatory actions.
300 Losses due to, for example, natural disasters, failure of public infrastructure, labor
disputes, terrorism, or kidnapping.
301 This includes the risks from back-office operations such as processing or settlement
and their systems; see Lam and Cameron (1999), p. 82.
302 This is especially important since the fee-based income of banks increased proportionally.
303 This part of operational risk is not restricted to back-office operations. It, rather,
addresses front-office applications such as strategy, client management, product
development, pricing, and distribution. See Lam and Cameron (1999), p. 82.
304 Despite the high entry barriers in the banking market, those competitors from the
new economy, in particular, challenge traditional, old-economy banks.