Smooth operators wage war on risk

The impact of the unforeseen is dawning on the financial sector, writes Richard Phillips
Management consultants are flying a new banner of "operational risk" to woo clients in the financial sector.

Following recent high-profile disasters in the sector - Barings, the Sumitomo copper scandal, and Deutsche Morgan Grenfell's unit trust debacle - there is growing recognition of the impact on business of "the unforeseen".

In the above cases, the problem was fraud, greed, or deception. But the essential nature of the problem, argues the consultancy arm of accountants Price Waterhouse, is not dissimilar to the infamous Hoover air fare fiasco, the Eurotunnel fire or the breakdown in London ambulance's computer operations two years ago. They all represented occurrences outside the normal ambit of a company's routine business.

More recently, Digital Equipment Corporation was fined $5.7m (pounds 3.4m) last week for its failure to inform customers of the potential for repetitive strain injury (RSI) from using its keyboards.

Price Waterhouse has compiled a worldwide database of companies that have encountered severe operational failures in the past three-and-a-half years, which has either put them out of business or burdened them with crippling losses. The sum of money involved totals of $700bn.

Trying to pin a definition on the subject is not so straightforward, however. An ICI spokes- man said: "Surely this is part of day-to-day management, particularly in an industry like ours? Like many of these fashionable theories, it's actually old-fashioned common sense." He added that much of the move may reflect financial services catching up with their manufacturing brethren.

Certainly it seems that financial services is the sector where the concept has won most converts. Barclays Bank now has a dedicated director of group operational risk, Dr Paul Dorey. "Our interest, from the board down, was to see our business in a total risk context," he said. To a bank, credit risk - the likelihood of a loan defaulting - was part and parcel of running the business. Market risk - potentially catastrophic swings in currency or derivative markets - was also well understood. Of these three risks, operational risk accounts for 15 per cent of the bank's total risk exposure.

Barclays defines operational risk as "the risk caused by failures in operational processes or the systems which support them", and includes "errors, omissions, systems breakdown, natural disaster and action such as terrorist attack." The bank went to Shell and the nuclear industry for tips. "These businesses have been dealing with these sorts of issues as part of their day-to-day routines for decades," said Dr Dorey.

Other companies are coy about revealing their efforts in this area. Chris Frost, at Price Waterhouse management consultants, said: "Companies who are introducing techniques for operational risk see themselves as gaining a competitive edge."

To the charge that operational risk is no more than an example of the Emperor's new clothes, he accepts this is often the attitude from companies when they are first approached. "But when we point out that this is an important element in corporate failure, they tend to sit up."

Some banks in the City have yet to wake up, however, to the warning posed by the Barings disaster.

As recently as July, Michael Foot, the head of banking supervision at the Bank of England, wrote to City banks warning that many of them were "still... blurring responsibilities between trading operations' front and back offices".