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Welcome Remarks Cathy E. Minehan Operation Risk Conference November 15, 2001 Auditorium Welcome Remarks
Cathy E. Minehan
Operation Risk Conference
November 15, 2001
Auditorium
Welcome to our Joint Conference on Capital Allocation for Operational
Risk, sponsored by the Federal Reserve Bank of Boston and the Board of
Governors of the Federal Reserve System. Let me begin by thanking all of you for
attending the conference, and extending a special thanks to Roger Cole and his
staff at the BOG for jointly sponsoring this conference.
The events of September 11
th
have had an understandable impact on
peoples decisions to travel to and attend a conference such as this. As you know,
many other conferences scheduled for this fall have been cancelled or deferred.
While the planning of this conference, like so many aspects of our lives, was
affected by those tragic events, the dedication of the presenters and attendees to
this topic allowed us to keep the conference on track, and maintain its high caliber.
Again, I want to thank each of you for being here and helping us put together such
a strong program.
The topic of operational risk has never been more relevant than it is today.
This conference should be a timely and very important vehicle for sharing ideas
and experiences that can further our understanding of operational risk. As you look
at the agenda, you will see that we have put together a program with
representatives from the entire spectrum of the financial services industry, 2
including its regulators and leading academics in the field of risk management.
This reflects a shared view that the question of how to best manage and measure
operational risk will be answered most effectively with input and insights from an
interdisciplinary exchange of ideas. Actually, it's my own bias that the experienced
practioners and regulators amongst us should lead the way, but the evolving
academic work needs to inform us as well.
We meet at a period of time likely not envisioned by those who began the
Basel II process a few years ago. It is a time of global downturn, perhaps a global
recession as those things are measured. It is also a time during which financial
systems have not everywhere shown themselves to be resilient. But here in the
U.S. and elsewhere, economic health is benefiting from strongly capitalized
financial institutions, unlike periods in the eighties and early nineties. This is not
simply a matter of good fortune. The focus of financial institutions and their
regulators on risk weighted capital ratios, and on a continual evolution in the
sophistication of risk management techniques has undoubtedly played a role. It
hasn't been perfect -- even Nobel Laureates have been led astray -- but I believe it
has been critical to the relative health of many institutions -- in the U.S. and
elsewhere -- as we enter this challenging period.
We also meet at a time no one would have ever envisioned -- the aftermath
of September 11. Here I believe there is strong evidence that risk management, in
particular operational risk management, played a critical role in the U.S. financial 3
system's resilience, and in the ability of the global system to cope as well. But
September 11 and the days afterward also reflected the many ways in which the
system both domestically and globally must be improved and made even more
resilient. That crisis, like others much less tragic in nature, revealed the cracks in
many institutions' assumptions, the single points of failure, the infrastructure
weaknesses that must be addressed both individually and collectively if the overall
system is to evolve to meet the challenges of the future successfully.
In that regard, it seems to me fortunate that the Basel Committee on Banking
Supervision, as part of the proposed new Capital Accord, dealt explicitly with the
issue of operational risk. While the proposal has generated controversy, it was a
critical step in furthering the process of fashioning an appropriate framework for
dealing with this important area.
In response to the January proposal and the more recent Working Paper on
operational risk, staff here at the Federal Reserve Bank of Boston together with
other Federal Reserve colleagues have been engaged in detailed analysis relating to
operational risk. This work has contributed to our evolving views on the
appropriate framework for quantifying operational risk, and has reinforced my
thinking that certain core principles should be at the center of any capital allocation
framework for managing operational risk.
First, I believe an operational risk framework should be tailored to reflect the
idiosyncratic business mix and operational risk management practices of individual 4
firms. This principle reflects the simple fact that operational risk varies by
organization based on the nature of the firms businesses operations, technology,
risk appetite, and risk management and controls.
Second, and possibly most important, any framework should meet the
critical objective of providing incentives for organizations to invest in the
technology, infrastructure, and controls that reduce operational risk. To achieve
this objective, the framework must reward, and should not be indifferent to or
penalize banks that invest to reduce their operational risk. By creating the proper
incentives, banking supervisors will align their goals with those of financial
institutions and reinforce the movement toward prudent management of
operational risk.
A third core principle I believe should be part of the capital allocation
framework is appropriate recognition of the use of risk mitigation techniques such
as insurance. Insurance has been a longstanding and effective operational risk
mitigant for financial services industries, and it and other evolving techniques
should be encouraged as part of the solution to managing and mitigating
operational risk.
Given the idiosyncratic nature of operational risk, there is understandable
difficulty in crafting a detailed regulatory regime that is risk-focused, provides
appropriate incentives to invest in managing operational risk, and encourages
flexibility and innovation in the area of risk mitigation. To achieve these 5
objectives, policymakers are considering an approach that allows banks to rely
heavily on internally generated capital allocation models. Unfortunately, many of
these modeling techniques are in their infancy. This poses challenges to the
financial institutions developing them, and to the supervisors who would have to
approve their use. I think this conference can be an important first step in
identifying and overcoming those challenges, as I am confident that the
information sharing and the interaction between leading experts in the field will
prove to be valuable to all.
I look forward to a productive day and a half. My thanks again for your
attendance and participation in this forum. Together we should make this an
informative and enjoyable conference.