This paper takes an in depth analysis of the circumstances that lead to the shutdown of GLH Derivatives and the London arm of Chicago's Griffin Company. As evident from the report that appeared on the BBC News, Chicago's Griffin Company inadequate internal structures (operation risk managers) is noticed to have neglected the dictates of operations risk, basically the Basel I and II Accords. For ease of understanding, the paper begins with the definition of operations risk. The analysis of the violations of the conventions of the two Basel by GLH Derivatives and the London arm of Chicago's Griffin Company then follow suit.
Operations Risk Management is defined as decision-making instrument that methodically assist recognize an organization’s operational risk as well as benefits and establishes the most applicable method for taking an action for each and every circumstance, (Ozdemir and Miu, 2008). As opposed to an organization’s operations and hazard analysis, usually carried out at the stages of an organization’s development, operations risk management is undertaken as at the time of operations usage, (Chernobai, Rachev and Fabozzi, 2007). An instance of risk management is before a flight is initiated. Basically, core reason why management of operations risk is put in place is to reduce accidents, asset preservation as well as to protect financial health of any business undertaking, (Ozdemir and Miu, 2008). Based on this definition of operations risk management, Chicago's Griffin Company is perceived to have contravened the goals of operations risk management and therefore is experiencing operations risk. The company incurs big losses. Besides, the company is defaulted by Nick Leeson. These signify operational risks that the company is faced with.
The company is noticed to have suffered from operational risk associated to its credit. This operational risk results from the company’s inadequate internal structures. Griffin Company is shut down simply because it incurred big losses that definitely are classified as credit operational risk. As stipulated in the first pillar of Basel II, the company operational risk employees/managers failed to meet the standards of credit risk computation, (Ozdemir and Miu, 2008). Operational risk and financial managers of Griffins Company never put in place capital charge for the credit operational risk. This is the reason as to why the two companies defaulted after a sole buyer, Nick Leeson, lost £6.2m on German derivative reserves, thereby resulting in a financial crisis. (BBC News). Besides, failure to implement sound credit scoring models as well as sound regulatory frameworks by company financial managers/employees made Griffin Company incur a loss as it is evident that a single trader had surpassed ten times the value he was restricted to, (BBC News).
. It is clear that the Griffin Company managers failed their duty. Company’s managers must at all times be accountable for the usual exercise of risk supervision for each activity, beginning with planning of the activity to its completion. The shutdown is also prompted with the Griffin Company managers’ laxity to adhere to the SFA rules and thus not fit and proper to continue carrying out investment business. The company clients are thus likely to incur risks.
The company had failed the test of separating the accounts of dissimilar traders, as was reported in the daily newspapers. The loss of £6.2m by a single trader as well as surpassing the amount to which he was limited to trading by ten times besides affects more than 100 traders, (BBC News). This results in company’s operational risk. This signifies company’s inadequacy in separation of diverse traders’ accounts and this contravenes SFA rules. This as well is another operational risk undertaken by the company. As stipulated in the Basel I Accord, companies must put themselves in a position that allows them to effectively manage credit risk. Different approaches therefore can be used to increase the company’s sophistication as well as risk sensitivity, (Ozdemir and Miu, 2008). Griffin company never put itself in a risk sensitive position. Due to the fact that this credit risk is more of a concentration credit risk type, Griffin Company ought to have calculated the credit risks associated with its lending to its traders/clients using either the standard approach, foundation IRB approach or and the advanced IRB approach. This was never the case and thus presents the company with operational risks. The company would have been better placed as its protection of regulatory capital would be sufficient to meet operational risks; only on condition that the operational risks associated with lending were computed. This thus forms part of operations risk incurred by the Griffins Company. For instance, as per the Basel I Accord, standard weight of risks is 0% for the government bonds, and 100% for consumer loans. Basel II accord however stresses that the minimal capital requirement should be 8% of the assets weighted risks to avoid closure resulting from credit risk, (Ozdemir and Miu, 2008). These were never implemented by the company hence part of its operational risks that lead to its shutdown.
In conclusion, to mitigate the credit risk, the company ought to have undertaken strategies like risk based pricing, use credit derivatives where the lenders are allowed to purchase credit derivatives, (Ozdemir and Miu, 2008). Also, the company ought to have employed diversification strategy by simply by expanding the pool of borrowers. The company ought to have as well used tightening strategy where the amount of credit allowed is restricted. This would have curbed the occurrence of a trader, Nick Leeson, exceeding --times ten-- the amount to which he was limited to trading. Operational risk management should be part and parcel and completely incorporated in an organization’s planning as well as execution of every operation it undertakes, (Flast and Dickstein, 2008). This should be continually applied by managers, as opposed to coming to the situation when a problem has already incurred, (Flast and Dickstein, 2008). Cautious evaluation of risks as well as the analysis of hazards created by actions undertaken may come to effect under differing conditions.
References
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Chernobai, A. S., Rachev, S T. and Fabozzi, F. J.2007. Operational Risk: A Guide to Basel II Capital Requirements, Models, and Analysis . 1st edition. Wiley.
Hoffman, D. G. 2002. Managing Operational Risk: 20 Firmwide Best Practice Strategiess. 1st edition. Wiley.
Flast, R. H. and Dickstein, D. I. 2008. No Excuses: A Business Process Approach to Managing Operational Risk. 1st edition. Wiley.
Ozdemir, B. and Miu, P. 2008. Basel II Implementation: A Guide to Developing and Validating a Compliant, Internal Risk Rating System. 1st edition. McGraw-Hill.
BBC Business News. 1998. The Economy Derivatives firms shut down. Retrieved at http://news.bbc.co.uk/2/hi/business/245510.stm
