Regulation and automation could push up operational risk for banks

Prof Suné Ferreira-Schenk

Operational risk has been identified as the primary source of reputational risk for South African banks. This is according to new research by Prof Suné Ferreira-Schenk, Finance and Investment professor at the Faculty of Economic and Management Sciences of the NWU.

Though banks have been subject to operational risks for decades, there are compelling reasons to anticipate that operational risk will only increase in the future as regulators demand greater transparency and banks rely more on increased digital technology automation.

Prof Ferreira-Schenk's research sought to identify the most significant operational risk events that would most likely result in reputational risk for South African banks.

A self-structured questionnaire based on potential operational risk situations was used to collect primary data from 417 depositors in Gauteng. The study asked participants to rate their chance of withdrawing funds from their bank account in reaction to seven operational risk events and one purely reputational risk event.

The operational risk events that were analysed were based on the global convergence of capital measurements for operational risk. These included (1) internal and (2) external fraud events, (3) employment practices and workplace safety, (4) clients, products, and business practices, (5) damage to physical assets, (6) business disruptions and system failures, (7) execution, delivery and process management. A single reputational risk that was included was the perception of the corporate reputation of the banks.

Pinpointing liquidity difficulties

A six-point Likert scale ranging from very unlikely to very likely was used for the rating. Depositors could use this scale to indicate how likely they were to withdraw their funds following an operational event, as well as how much (in percentage terms) they were likely to withdraw. This information can be used to identify prospective liquidity difficulties for banks or even bank runs. A bank run occurs when a large number of depositors remove their money from a bank at the same time owing to fears that the bank will collapse.

Events having a mean score of 3,5 or above for the chance of withdrawal were classified as serious. According to the findings, external fraud had the greatest reputational risk rating, followed by execution and delivery of banking activities and processes.

Six out of the eight events were classified as severe in terms of the percentage and likelihood of deposited funds being withdrawn. Seven out of the eight events were deemed severe in terms of their potential to negatively impact depositors' perception of the bank after an operational event.

Most of the research in this field has come from developed countries. As a result, Prof Ferreira-Schenk's research provides empirical evidence from a developing region to identify the most severe operational incidents that can harm a bank's reputation.

For more information about her research, you can send an email to Prof Suné Ferreira-Schenk at 23261048@nwu.ac.za.