Compliance managers in financial institutions know that protection against operational risks is more than just a regulation. The responsibility to harmonize business activities and regulatory requirements requires a 360° view of the big picture on a daily basis. But how can operational risks be managed effectively when the human factor is always at the center of attention?
A financial institution's risk management is heavily influenced by operational risks. These include all risks arising from internal processes, systems, people or external events that could jeopardize the stability and success of the institution.
The daily work of compliance officers is therefore determined by operational risk issues. How can the entire life cycle of a bank - from the recruitment of an employee to the termination of a customer relationship - be monitored seamlessly and risk-free? What processes must be adhered to in order to protect the interests of the bank, its clients and its employees? Who bears responsibility when risks occur? Are all imponderables calculable?
Customers, authorized signatories, sales partners, buyers and sellers of goods and services, employees and many other people, who are referred to as ultimate beneficial owners, stakeholders or similar, have also been an issue for companies in general and banks in particular for years. Verifying this has now become unavoidable.
A bank's reputation can be significantly damaged by various sources associated with politically exposed persons (PEPs). PEPs are high-ranking public officials, their family members or close associates and, due to their position, pose an increased risk of corruption and money laundering. If banks are associated with questionable PEP transactions, they face financial penalties as well as serious reputational damage.
1. Inadequate due diligence
When banks do not conduct comprehensive risk assessments when dealing with or supporting PEPs, the repercussions can be severe. For example, if a bank is associated with a PEP that is later charged with corruption, its reputation suffers considerably.
2. Insufficient transaction monitoring
Suspicious money flows must be identified and reported. If banks are negligent and overlook conspicuous transactions by PEPs, this can lead to investigations and negative reporting.
3. Violations of regulatory requirements
Financial supervisory authorities such as BaFin, FINMA and the FCA have strict regulations for dealing with PEPs. If these are not complied with, there is a risk of high fines and a considerable loss of trust among customers and investors.
4. Negative media reports and whistleblower revelations
Adverse media, social media, and artificial intelligence, including fakes and deep fakes, pose further challenges. Scandals surrounding PEPs and banks quickly hit the headlines. Whistleblowers, investigative journalism and leaks such as the "Panama Papers" or "FinCEN Files" have repeatedly demonstrated the detrimental impact that associations with questionable PEPs can have on banks.
Do you really do business with people who wrongly have a bad reputation?
The exact number of PEPs is difficult to determine, as the definition of PEPs varies from country to country. It is estimated that there are over 3.1 million PEPs worldwide, which are recorded in specialized databases such as those of LSEG World-Check or Dow Jones Factiva. The Panama Papers, the Cyprus Papers and many others have made negative headlines in various industries.
Do you do business with people who have a bad reputation?
Banks must take dealing with PEPs extremely seriously. A solid due diligence strategy, strict internal controls and a proactive approach to legal compliance are key to reducing reputational risk. Those who act negligently here risk high penalties and as well the long-term loss of customer trust.
The exact number of sanctions currently imposed worldwide is difficult to determine, as it varies constantly and is recorded differently by different countries and organizations. However, some estimates provide an overview:
Against Russia: until the start of the war against Ukraine on February 24, 2022, around 2,500 sanctions were in force; since then, up to 14,500 more were added by the end of February 2024. Since June 2024, the European Union has further tightened its sanctions against Russia in response to the ongoing war of aggression in Ukraine and to prevent the circumvention of existing measures. Targeted measures have also been launched against companies that have violated the existing sanctions through financial transactions and deliveries of prohibited EU goods. The 15th sanctions package was issued in December 2024. Sanctions have been imposed on 52 additional vessels to curb the illegal transportation of goods in violation of oil sanctions. The sanctions list was expanded by listing 84 additional individuals and entities, for the first time including Chinese actors that provide military support to Russia.
Worldwide: Currently, approximately 70 countries are subject to sanctions, with around 200 active sanctions programs in place.
These figures illustrate the extensive use of sanctions as an instrument of international strategy. And sanctions are constantly being tightened.
Now, do you do business with sanctioned persons?
Numerous internal and external factors influence the risk management of a financial institution. These factors determine how risks are identified, assessed, managed and monitored. The following is an overview:
1. Corporate strategy
The institution's risk appetite and strategic objectives influence the risks it takes.
2. Organizational structure
The structure of an organization, whether centralized or decentralized, can significantly impact the efficiency and allocation of responsibilities within risk management.
3. Risk culture
The attitude of employees and managers towards risk and compliance plays a key role.
4. IT systems and data quality
Sophisticated systems and reliable data are crucial for risk modelling and reporting.
5. Financial resources
Solid capitalization and liquidity buffers influence the ability to bear and mitigate risks.
1. Regulatory / Compliance requirements
Regulations such as Basel III, Solvency II, MiFID II or the requirements of the European Central Bank (ECB) and BaFin (in Germany), FINMA (Switzerland), FMA (Liechtenstein), FMA (Austria) set the framework for risk management. And now, the EU's new anti-money laundering authority based in Frankfurt, AMLA for short, is ensuring tighter controls to combat money laundering and the financing of terrorism, as well as the EU Single Rulebook.
2. Market development
Interest rate fluctuations, currency movements and volatility on the capital markets influence risk positions.
3. Economic environment
Factors such as inflation, recession or geopolitical uncertainties have an impact on credit quality and other risks.
4. Technological innovations
Developments such as artificial intelligence (AI), blockchain or cyber risks open up new opportunities, but also challenges.
5. Competitive pressure
Institutions have to offer innovative products, which is often associated with additional risks.
6. Climate risks
Environmental and social risks, such as the transition to a CO₂-neutral economy, are becoming increasingly important (ESG risks).
Effective risk management therefore requires consideration of all factors and continuous adaptation to dynamic changes. Transparency, resilience and the use of modern technologies are at the heart of this. But let's get back to operational risks.
Operational risk is the risk of losses caused by operational risks, such as those caused by
We, therefore, consider it necessary to implement processes that ensure the appropriateness of decisions, prevent human or system failure, mitigate external events as far as possible and enable the correct and complete recording and reporting of risks at all levels of an organization.
Let's focus on "a 360° view of operational risks" and examine risk management from the "outside-in" approach. A bank's business partners and third-party relationships should be closely examined for potential weaknesses. This is particularly important in the context of third-party due diligence to protect the bank from unforeseen risks. But the view goes further: the entire compliance ecosystem needs to be examined.
And what happens when we turn risk management around? The focus is no longer on the outside, but on the inside. The focus is on the people in the bank. This enables a 360° view because every compliance officer knows that employees and their actions are directly linked to compliance. From onboarding to offboarding, it is important to ensure that rights and duties are clear, conflicts of interest are avoided and compliance rules are adhered to.
1. Complexity of the organization
Extensive business processes and international activities increase susceptibility to process and system errors.
2. Risk culture
A lack of awareness or communication of risks at all levels of the organization can lead to considerable damage.
3. IT and cyber risks
Weaknesses in the IT infrastructure or inadequate protection against cyber-attacks represent significant threats.
4. Employee qualification
Insufficiently trained staff or high staff turnover increase the likelihood of errors.
5. Control systems
Inefficient or incomplete control mechanisms make it difficult to identify risks at an early stage.
Imagine an employee at your bank is responsible for onboarding a new business partner. The compliance process runs smoothly, but transaction monitoring later reveals irregularities. One reason for this may be that the review periods are too long and the processing of transaction alerts is not risk-oriented. This underscores the significance of a robust system that not only tracks the present moment but also oversees the entire lifecycle of the relationship. Rule-based automated monitoring supports the compliance process and helps the human factor to meet defined deadlines. Because trust is good, control is necessary.
Operational risks are one of the most complex challenges for financial institutions, as they affect almost all areas. Effective risk management must identify internal vulnerabilities, anticipate external influences and at the same time implement robust prevention and response measures. Successfully managing these risks hinges on the integration of innovative technological solutions and a robust risk culture.
1. Process optimization and automation
Clear and lean processes reduce sources of error and increase efficiency.
2. IT security and data protection
Investments in robust IT systems and cyber security measures minimize technological risks.
3. Training and awareness-raising
Regular training and a strong risk culture promote awareness of operational risks.
4. Emergency plans and business continuity management
Proactive preparation for unexpected events safeguards business operations.
5. Monitoring and reporting
Use of modern technologies for real-time monitoring and analysis of risks.
The sheer quantity and rapid flow of data necessary for efficient risk management can be overwhelming for financial institutions. This data influx requires sophisticated systems capable of processing and analyzing vast amounts of information in real-time. Without such systems, organizations may struggle to keep up with the pace of data generation, potentially missing critical insights that could inform risk mitigation strategies. The challenge lies not only in managing the volume of data but also in ensuring its accuracy, relevance, and timeliness, which are crucial for making informed decisions and maintaining compliance with regulatory standards.
According to a study by Forrester Consulting from 2023, the total cost of FinCrime compliance in the EMEA region amounts to 85 billion US dollars. That is a considerable sum. Nearly 500 financial institution decision-makers in the EMEA region who are responsible for FinCrime compliance strategy indicated that the top three cost drivers are growing FinCrime regulations and regulatory expectations, increasing automation requirements, additional data and tools for FinCrime compliance, and a sharp increase in criminal threats. Choose software that helps you manage risk and use reliable data sources to identify and avoid risks better.
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