The Hindu Business Line : Data mining key to control operational risks in banks

Of these, credit risk is easily measured and the capital requirement on that count could be lesser than now, a view supported by studies done by Investment Information and Credit Rating Agency (ICRA).

On market risks, which relate to interest rate movements, banks can do little other than hedging. The real scope for a bank to keep capital lower (relative to other banks) is in operational risk. The key factor here is the ability to measure operational risk. In this regard, the new private sector banks seem to have an edge over other banks. Measurement of operational risk involves extensive IT applications in data mining.

Under Basel-II, banks initially will adopt the `basic indicator approach' for operational risk. As per RBI's recommendations, banks are to "hold capital charge for operational risk equal to the average of 15 per cent of gross annual income in the last three years." But overtime, banks could migrate to the `advanced measurement approach' for computing capital charge for operational risk.

Asked on the systems they had to measure operational risk, heads of many public sector banks that Business Line spoke to, gave rather non-committal answers such as "we are awaiting RBI guidelines" and "we would keep enough capital as cushion." An exception here was the Indian Bank, which said that it started building a database as early as two years ago to check fraud or error patterns over the last seven to eight years.

New private sector banks, on the other hand, have been putting systems in place. For example, ICICI Bank has constituted a "group to look at operational risk," which is in charge of building the database. Says Mr Balaji Swaminathan, who heads the Corporate Banking division, "You have to have millions of data. You have to see how often the transactions have resulted in financial liability to the bank — instances of fraud, negligence and errors."

Putting all the data points together and finding out trouble spots are the keys to control operational risk. "When operational risk capital does kick in, we would have the data to prove to the regulator that we have a sophisticated system to capture the risk, even with smaller capital. It is not enough to say `I can manage with so much capital'. You have to be able to support it," Mr Swaminathan said.

UTI Bank has similarly been putting data together. Mr L. J. Fonseca, Senior Vice-President (Risk), says that most of the data is available in the bank, but a system has to be created to piece them together. "Currently, the data on operational risk is captured by different wings of the bank during their routine functions and at times, a holistic view is not taken on account of distributed origin of such data."

The bank is therefore trying to "create a unified database to capture and mine all operational risk-related data." It isin the process of buying software that "has in-built analytics to identify trends and patterns" that might result in loss.

HDFC Bank is aiming to mitigate operational risks with "higher automation levels for checks and controls." Says Mr Bhavesh Zaveri, Vice-President, Branch Operations and Product Development, "We have been monitoring and measuring the operational risk in the form of any variance in client turn-around time, observations in internal audits, RBI inspection reports, staff negligence, errors or fraud." With the data and measurement tools available in-house, the bank expects to soon move towards the advanced measurement approach.

Observes Mr Balaji Swaminathan, "Unlike credit risk, which the clients are happy to pay for, my own sense is that the customers are not going to be comfortable paying for operational risk. That is a cost the shareholder has to bear. So we have to keep it minimum."

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