Operational risks are quite common in the area of financial services. Financial services include everything from banks to various other financial intermediaries. Financial services play a very important role in the economy. Therefore failure of any major financial services provider, like a big bank, causes considerable pain for the larger economy.
This was seen once again during the 2008 financial crisis when investment bank Lehman Brothers went bankrupt and was subsequently liquidated. The cause of 2008 financial crisis was pinned down to failure in risk management at major banks and investment banks, like Lehman Brothers.
The Bank of International Settlements (BIS), located in Basel, Switzerland, is the international banking regulator. It sets the operational and risk management norms for banks across the world. The BIS has recommended that by using Six Sigma, banks and other financial institutions can greatly improve their operational risk management. Operational risk in a bank can be frauds, breach of rules and processes relating to operations, impairment of physical assets or impairment of the technological infrastructure.
Six Sigma strives for reducing variation in processes. This means that it strives for setting standard operating processes. Standardization of operating processes reduces the risk of failure in implementation of operational practices. Six Sigma also strives for continuous improvement of processes. Continuous improvement in operational processes at financial institutions can greatly reduce operational risks.
One major Six Sigma tool is Failure Modes Effects Analysis (FMEA). The FMEA can be applied effectively for managing operational risk at financial institutions like banks. The FMEA tool basically involves documenting the failure points of a process. The risks associated with each failure point are then prioritized on the basis of the damage or harm that can be brought by materialization of that risk. Once the risk prioritization has been done , risk mitigation plan is made. By applying these steps of FMEA to processes at financial institutions, the operational risks can be brought down considerably.
Key risk indicators (KRIs) are another Six Sigma tool that can be applied for making risk management at financial services more effective. The KRIs can be plotted on a control chart. The frequency of occurrence of a KRI can give an idea about the probability of the risk getting materialized. Early identification of a risk is one of the most effective ways of risk management.
In days to come increasing number of banks and other financial institutions are likely to apply Six Sigma for risk management. There is no stopping for Six Sigma it seems – from the manufacturing workshops it is now spreading into the august vaults of banks.