An Exploration of Operational Risk Management and Basel Implementation in Banking: a Developing Economy Perspective

Abstract

Within the past decade and a half, Operational Risk (OR, OpRisk) has evolved from being the risk without a definition, a residual category for risks, to become one of the dominant risks in the banking world. The Basel Committee on Banking Supervision (BCBS) issued regulatory frameworks and principles that cut across geographical diversities, in managing OR globally, and in strengthening systemically important banks. Although the Basel accords originally excluded developing economies, they have become globally accepted guiding principles for managing risks in banks. Nigeria, a developing economy embraced the Basel principles and frameworks on Operational Risk Management (ORM). As a practice-based discipline, literature on ORM theory in banking is scanty and even more scarce in African banking systems. This qualitative case study sought to explore operational risk management theory and practice in the context of Nigeria’s banking system, in order to identify how Nigerian banks have adapted the application of Basel’s ORM principles to suit their unique settings, manage operational risk, and achieve/maintain the foundation needed to meet global standards. The relevance of the study subsists in charting a trajectory of theoretical foundation for the management of OR, and to identify the impacts of implementation of Basel frameworks from a developing economy context. Framed on interpretive worldview and constructive realism, data were obtained from documentary sources, and from semi-structured interviews of relevant persons in banks and regulatory institutions, including a consolidated United Kingdom (UK) banking institution. The data were analysed through detailed transcription, extraction, coding, thematic characterization and presented through descriptive and inferential discussion of the categories derived from aggregated patterns.

The first category of findings supports the thesis to postulate that studies of uncertainty and behavioural factors as root causes of risk, provide substantive theoretical underpinnings for the phenomenon of operational risk in banking. Furthermore, there are significant underlying linkages between risk, governance, behavioural and uncertainty theories as they can inform the operational risks faced by banks because of people, processes, systems and external events. The theoretical and practical aspects of ORM are then unpacked by examining the application of Basel’s ORM framework within the banking sector in Nigeria, to identify the challenges and opportunities posed in the process. Ultimately, the researcher propounds that superior management of operational risk in banks, require superior customized collaboration, derived from a purposeful engagement of both regulators and banks, under the Basel principles and pillars. The findings also show that Nigeria’s consolidation agenda led to the introduction of risk-based supervision which formed a solid foundation for the application of Basel. The application of Basel principles has in some banks, provided innovative tools for improved bottom line in addition to appraisal and reward systems through bank-wide risk ownership, and new product development. Thus, a positive handshake is established between OR and HR. It has also revealed that some Nigeria banks are quite advanced in their ORM and Basel implementation, in contrast to Basel position on developing economies. Other findings indicate that: i) development of knowledge and competency can be innovatively deployed for building benchmarks of best practices and support systems that are mutually beneficial to all, as opposed to its traditional competitive advantage focus ii) asymmetric regulation results in banks bearing responsibility for fintech risks that could otherwise be borne by third parties iii) information remains asymmetrical and sometimes opaque between bankers and regulators while the same is shared among bankers affirming behaviourist perceptions. A few significant differences exist between UK and Nigeria in the application of Basel’s ORM particularly in material risk categorization, as well as specialization of heads of groups. The researcher suggests that policy designs and standards by global supervisors would perform better when made inclusive of all economies, both developed and developing economies. Also, Nigeria regulators and banks should pivot on the common objectives, leverage on cohesive competencies, and bridge regulatory asymmetry, so that both sides can seamlessly deliver the mutual goals of financial stability and operative global banks.