Services to help banks assess operational risk are in the spotlight.
Ernst & Young LLC in October began distributing Internet software developed by J.P. Morgan & Co. to help companies measure operational risk. Meanwhile, NetRisk Inc - a New York-based company founded by Gene Shanks, the former president of Bankers Trust Corp. - is soliciting banks to join a clearinghouse that would track operational risk.
Operational risk was tagged as a $7 billion problem for financial institutions in a PricewaterhouseCoopers study released in November. Such risk, which stands apart from market and credit risk, includes check fraud, lawsuits, technology breakdowns, improper sales practices, and rogue securities trading.
Indeed, recent examples illustrate how severe operational risk can be. For instance, Bank of New York Corp. employees allegedly have helped the Russian mob engage in laundering billions through its accounts.
And according to The Financial Times, Deutsche Bank AG's payments processing operation in Frankfurt reportedly suffered a technology glitch last week causing a daylong shutdown. Sources said the problem was at the company's euro-processing operations in Germany and that it had little impact on U.S. banks.
Deutsche Bank, which the source said processes 6% of all euro transactions, reportedly said the problem was related to software recently installed at both its main processing site and its backup site. Company officials did not return phone calls.
Craig Spielman, vice president and head of J.P. Morgan's global IT controls, said that operational risk is growing as banks run increasingly global operations and perform more tasks over the Internet.
"Especially as you move to distributed technology and e-commerce, how you cover operational risk can really impact your ability to do business," he said.
J.P. Morgan developed its Horizon software in 18 months and installed it last March. Ernst & Young will install the software for customers and give Morgan a cut of the proceeds. Apart from J.P. Morgan, no other banks are using the software.
Christopher Karow, a partner at Ernst & Young in New York, said Horizon has a lengthy sales cycle "because we are asking organizations to change the way they manage risk, and that means people changing behavior, and organizations changing the way they are managing themselves."
J.P. Morgan is using the software to assess its operations on a quarterly basis. Mr. Spielman, who led the Horizon initiative, said the firm has cut the time it takes to perform audits from days to hours.
"It used to take us about three or four weeks and a lot of grief to do these things," he said. Horizon "has improved the consistency and quality of the data, and we can now tell management whether we are doing better or worse."
NetRisk's clearinghouse is also aimed at improving the quality of data for measuring operational risk.
The Multinational Operational Risk Exchange would collect data from banks confidentially to develop models to measure and manage operational risk. Included in the data would be the frequency of various events and the severity of the losses.
"One of the biggest issues with being able to quantify operational risk is just the general lack of loss information, particularly the news that doesn't make it to the financial press," said Robert Ceske, managing director and head of NetRisk's operational risk management division. "These things are not necessarily catastrophic, but potentially embarrassing."
Lev Borodovsky, executive director of Global Association of Risk Professionals, which is sponsoring the clearinghouse, said the goal is to set up a service that is very confidential and closed.
Operational risk "is very hard to get your fingers on because it is such a touchy issue," he said. "No one really wants to open up and release any kind of historical information on operational problems because it is embarrassing."
NetRisk, founded in 1997, would run the clearinghouse and provide participants with services and software, including RiskOps, its Internet-based operational risk management software.
The Multinational Operational Risk Exchange is scheduled to become operational next year and have 50 banks after a year of operation. So far, it has lined up six potential participants. They will pay an initiation fee and ongoing service charges.
NetRisk, which would run the exchange as a Bermuda-based, not-for-profit company owned by financial institutions, has scheduled a meeting Wednesday to reveal more details of service and solicit more participants.
Regulators also are encouraging greater recognition of operational risk.
The Bank for International Settlements identified a potential need to incorporate operational risk as a component of capital adequacy in a June document.
The global banking regulator "wants to see the marketplace and banks move forward" and get their "hands around operational risk," Mr. Karow said.
"The speed in how we do things is making operational risk more of a topic, and corporations really need to manage it better and understand where there are problems," he said.
