The topic of risks faced by the banking system is not a new concept. Since the global financial crisis in 2008, financial institutions including banks have established advanced systems to control financial risks. However, operational risks haven’t been dealt with effectively. In this article, the topic of Banking Unit Risks and challenges will be fully touched on for the purpose of clarity.
Operational Risk
Recently, operational risk has been elevated to a different risk category that can shape the risk profile of all financial institutions in general. This elevation is resulting from the BCBS- Basel Committee on Banking Supervision. BCBS defines operational risks for banks as “the risk of loss resulting from inadequate or failed internal processes, people and systems, or external events”.
The reason operational risk is more complex is because it is not always easy to measure and it involves more risk types. Also, active risk management involves advanced visibility into different processes and activities across the institution. Operational risk must be well evaluated and managed by Banking units and other financial institutions. This can be done through various tools and mitigation strategies.
Causes of Operational Risks
Generally, banking unit risks can be caused by factors like technology, people and regulatory or compliance issues. Examples of technological causes are hardware, software, cyber security and privacy. Examples of people’s causes are employees, customers, vendors and other stakeholders.
Cases of Operational Risks
There are so many examples of risk categorized as operational. Here are some of them:
- Human error
- System Failure
- Fraud
- Inadequate or failed internal process
- Cybersecurity events, for example, when data is breached
- Inadequacy of a trained staff
- Down time
- Breakdown of business process controls
- External events, for example a pandemic or natural disasters
Major Operational Risks faced by Banking Unit
Banking and financial services generally face different levels of risks. These risks have been a challenge for banks for a long period. They are caused by new business models, complex value chains, increasing digitization and regulatory challenges. Let us see some of these operational risks:
Cybersecurity
Even as financial institutions embrace developed methods of securing their system from cyber attacks, they are still being faced with more threats. Ransom ware and phishing have become more frequent and have not ceased to affect the bank’s operational continuity.
This became more rampant, especially in the post pandemic world where cyber criminals leverage security weaknesses of organizations to perpetrate cybercrime.
Fraud
Banking Fraud can be internal and can also be external. Internal fraud could be from forgery, asset misappropriation, non compliance, bribe, tax or theft. Fraud caused by external parties include money laundering, hacking, check fraud, theft, system breaches, and data theft.
The risk of fraud keeps increasing as a result of different factors. For example, availability of sophisticated and developed fraud tools, increase in transaction volume and the security gaps resulting from increasing digitization and automation in banking processes.
Banking Units Challenges
Banking Unit as a system of banking also faces some certain challenges:
Lack of Mobility Funds
The Banking unit only gets funds in their local area. They do not attract funds from outside their locality. So in pursuit of higher interest rates, there is a high possibility of these local funds flowing out to the large money market. This is because the Banking Units are unable to pay high interest rates on loans.
Limited Resources
Banking units do not have a lot of resources at their disposal. If there is an event of a financial or economic downturn, and major stakeholders or depositors start withdrawing their funds, the bank will fail.
Unhealthy Competition
As different companies establish a banking unit in a town, this can result in unhealthy competition between them. Since Banking units are localized and are usually in a small area, they will always be finding ways to survive in that limited area.
No Diversity in Service Provided
Banking unit can not provide diversified banking service to its clients since it doesn’t have other branches. Even if they want to, they will have to get it at a higher cost. For example, some business owners may be picky when it comes to choosing the bank they want to work with. They may insist that they prefer a branch of their city bank in their local area for their business transactions.
Not being able to spread risk
This is one challenge that Banking Units face often. Since their operations are localized in a particular area, there could be a big problem if one of the major customers fail to repay the loan in time.