MARKET RISK
ARIZONA STATE UNIVERSITY
IEE 454 - RISK MANAGEMENT
WEEK 7
Definition of Market Risk
Market risk in the Indonesian dictionary, market risk is a condition experienced by a company
caused by changes in market conditions and situations outside of the company's control. This is
also commonly referred to as comprehensive or overall risk, because it is general in nature and is
experienced by all companies. Risks usually occur in financial and administrative reports due to
price changes in the market.
Market risk can also be said to be the risk faced by investors due to a decline in the market value
of a financial product arising from factors affecting the market as a whole and not limited to a
particular financial commodity. Usually called systematic risk, market risk arises due to
uncertainty in the economy, political turmoil, geographical factors, or the occurrence of a
recession and can only be hedged, but not eliminated by diversification.
According to Masyhud Ali, in the book Risk Management (2006) Market risk is the risk of loss
suffered by the Bank, as reflected in the bank's on and off balance sheet positions, due to
changes in market prices or bank assets, interest rates and foreign exchange rates, market
volatility and market liquidity.
Market risk can also result from the risk that an entity may incur losses as a result of fluctuations
in market price movements, due to changes in the prices (volatility) of fixed income instruments,
equity instruments, commodities, currency exchange rates, and related off-balance sheet
contracts. Or it may also result from risks stemming from general foreign exchange risk and
bank-wide commodity risk in the banking trade or book.
The development of information technology in the Digitalization era is so fast, resulting in
technology that continues to grow, especially in the business sector. Therefore, the initial
business risk is market risk caused by changes in macro market conditions, which many business
people are unable to stem. This market risk is caused by changes in the sentiment of financial
markets such as bonds and stocks. Such changes generally occur due to certain conditions, such
as the political situation, economic recession, and inflation.
In certain situations, market risk can also lead to systematic risk, which cannot be avoided by
businesses because it causes capital loss on investments. However, it usually has no impact on
long-term investment risk.
Forms of Market Risk:
There are two forms of Market Risk, namely:
1.
General market risk. This risk is usually experienced by all companies caused by a policy
carried out by related institutions where the policy is able to affect all business sectors. For
example, when the Central Bank of a country conducts a tight money policy with various
instruments such as raising the BI rate. Where the policy of raising the BI rate will have a
comprehensive influence on all business sectors related to interest rate related instruments.
That one of the important parties is considered to be directly related to interest rate related
instruments is banking. That is, they take out credit and deposit some of their money with
the bank. For example, when the BI rate is raised, bank lending rates will follow these
conditions, namely also raising lending rates, especially if the bank applies a sliding rate
interest calculation. The calculation of a sliding rate credit is a calculation of interest charges
on the principal value of the loan will decrease from each month to the next month, which is
adjusted to the decrease in the value of the principal loan as a result of the payment of
principal loan installments made by a debtor. Some of the things that can lead to General
Market Risk include:
a.
Foreign Exchange Risk
Basically, in financial science, two forms of markets are known, namely the capital
market and the money market. These two market forms are in principle interrelated with
each other, working hand in hand in an effort to create conducive and dynamic
economic conditions so that in the hope that they will be able to encourage economic
growth.
The financial market is commonly known as a place where various financial activities
are carried out both in the form of selling securities carried out by the capital market and
also the place of sale of currency (currency) as carried out in the money market.
At the time of the implementation of the floating exchange rate system in the 1970s was
the beginning of the foreing exchange, since then the currency conditions in the world
have been integrated in one form of market where in particular we can see that the
application of the system allows many parties who are usually involved in playing in the
forex market (foreign exchange).
This risk arises due to exchange rate fluctuations between domestic and foreign
currencies, and the most affected to this risk are MNCs that operate across geographies
and whose payments come in different currencies.
b.
Interest Rate Risk
Interest rate risk is a risk that is experienced as a result of changes in interest rates that
occur in the market and can affect the company's income.
This risk arises when the value of a security falls as interest rates rise and fall over the
long term. It is a broader term and consists of several components such as basis risk,
yield curve risk, option risk, and repricing risk.
c.
Commodity Position risk (Commodity Value Change Risk)
Commodity position risk is a situation and condition where there is a loss due to changes
in the price of commodity goods in the market caused by certain factors, this condition
will be even worse when the commodity goods have been contracted in a contract
agreement (commodity contract) and the information has reached the market.
Like foreign exchange risk, commodity price risk arises due to fluctuations in the prices
of commodities such as crude oil, gold, silver, and so on. However, unlike exchange rate
risk, commodity risk affects not only multinational corporations but also the general
public such as farmers, small micro-enterprises, business entities, commercial traders,
exporters, and governments.
According to Masyhud Ali (2005) said that Commodity position risk from the perspective
of In banking, the potential risk of loss to the bank as a result of adverse changes in
commodity prices affecting the bank's positions related to commodity contracts. An
example in banking is "where losses suffered by investment banks that trade or
commodity derivative products as a result of volatility in the price of a particular
commodity. Banking is a mediation institution that is tasked with bridging parties who
need help with the aim of making various affairs effective and efficient. In this context,
banks may become entangled in the risk space when these parties are unable to carry out
their duties effectively.
Trading on the commodity exchange is volatile, ups and downs occur in a short time.
This situation is often used as an advantage by speculators, namely by buying at low
prices and selling at high prices, where this is seen as a capital gain where the profit is
obtained from the difference between the purchase price and the selling price.
Conditions in the field are often utilized by speculators to take advantage of inaccurate
information. Thus creating an ineffective and inefficient market where a condition of
various information cannot be obtained easily and quickly.
d.
Equity Position Risk
Equity position risk (risk of changes in wealth) is a condition where the company's
wealth (stock and shares) experiences changes from the norm so that these changes
have an impact on profits and losses for the company.
Equity price risk refers to changes in the share price of a financial product and since
equities are most sensitive to any economic changes, equity price risk is one of the
biggest parts of market risk.
e.
Political risk
Political conditions are very important and have a major influence on the stability of
markets and the economy of a country. Therefore, political stability promises the
creation of sustainable development, but if the leader and related parties in a country are
unable to create a conducive situation in the political field, there will be a leadership
crisis that will have an impact on the economic system and can even lead to inflation,
the currency exchange rate will be high, there will be turmoil, investors will withdraw
their investments until the situation returns to normal.
2.
Specific market risk, in this situation it is said to be specific risk due to a form of risk that is
only experienced specifically in one sector or part of the business without being
comprehensive. for example:
a.
An announcement issued by an appraisal agency where the appraisal agency has a good
reputation and is recognized by the public. That they announced PT. ABC had low
performance and had large debts and published reports so far to the public is not in
accordance with the truth. As a result, the company's shares and bonds immediately fell
so that the company's shares and bonds were not followed by other companies.
b.
A company where management commits fraud against customers and gets caught, the
impact will affect the company's reputation.
c.
One of the companies sells packaged food products that are not Halal certified so they
are considered to contain ingredients that are not recommended for sale in general. For
example, food products that contain animal fat and are not halal certified, thus, the
product violates the provisions of the MUI. If caught, it will have an impact on the
future of the product because it will be revoked in the market which results in losses.
Source of Market Risk:
There are several sources of Market Risk, including:
1.
Company Business Strategy and Policy
In market risk strategies, there are several factors that influence trading strategies, namely:
a.
Company trading characteristics
b.
The company's market position in the industry
c.
Product complexity and customer characteristics
Business Strategy related to interest rates in the banking book, Several indicators used,
namely the characteristics of business activities that have an impact on the banking book
interest rate risk in the bank book and key customer characteristics, market position in the
industry and customer characteristics.
2.
Potential Interest Rate Risk Losses in Banking Book
Two parameters are used, namely interest rate exposure in banking book (IRRBB) based on
gap reports (income perspective and economic perspective). and unrealized loss of securities
compared to capital.
3.
Portfolio Volume and Composition.
The parameters used are as follows:
Ratio: trading assets, derivatives, and fair value options to total assets
Ratio: trading, derivative, and fair value option liabilities to total liabilities
Ratio: total structured product to total assets
Ratio: potential gains/losses on trading assets, derivatives and fair value options to operating
income.
Ratio: total derivatives to total assets Ratio: net foreign exchange position to total
capital
Ratio: available for sale category equity to total capital
Ratio: financial assets with remaining maturities above one year to financial liabilities with
remaining maturities above one year.
Market Risk Case Example:
In everyday life, examples of market risk can be seen in the following cases:
1.
Market risk for banks arises due to the weakening of the rupiah exchange rate during the
first semester of 2020 which tends to fluctuate and depreciate, the rupiah exchange rate
began to depreciate in March 2020 along with the Covid-19 pandemic which began to
spread to Indonesia. The weakening of the rupiah exchange rate was due to the spread of the
Covid-19 pandemic throughout the world, including Indonesia, which led to an increased
risk of global uncertainty so that investors tended to shift their investment funds to safe
haven assets, such as gold, developed country government bonds, and world currencies, such
as the United States dollar. This action resulted in capital outflows from emerging market
countries, including Indonesia, which caused the depreciation of almost all world currencies
against the US dollar.
2.
When I was running my coffee business, I had just created a new menu, "Es Kopi Aren",
which was trending and in demand by many customers. But suddenly a new menu came out
that became a consumer favorite, for example "Ambyar Coffee". Even though at that time I
had bought quite a lot of ingredients to make Es Kopi Aren. This made the businessman
suffer losses due to the high stock of ingredients that were no longer needed.
3.
Market risks related to online sales, for example:
a.
The existence of fictitious buyers
b.
Constantly changing market prices
c.
Risk of damaged goods when delivering goods to buyers
d.
Complaints from buyers because they are not as expected.
4.
Another example of market risk is that as market prices move
In a direction that is detrimental to the organization, for example, an industry has a portfolio
of stock securities purchased for Rp.1 billion. Suppose the share price falls, so that the
market value of the shares drops to IDR 800m. The industry faces a loss because the value
of its stock portfolio drops by Rp. 200 million. The loss is due to the stock price moving in
an unfavorable direction (in this case down).
How to deal with market risk:
After knowing what market risk is, and also examples of market risk, it is also necessary to know
how or methods of dealing with market risk, the following are ways of dealing with market risk,
namely:
Market risk is systematic risk that cannot be minimized by portfolio diversification alone.
However, this risk can be reduced by hedging strategies, most notably by using futures or
options contracts, although market risk cannot be completely eliminated.
Systematic risk is different from systemic risk. Systemic risk is usually applied to an event that
can stimulate the collapse of a particular industry or economy, whereas systematic risk refers to
the risk of the market as a whole.
In general, when we talk about market risk, we are talking about variables that are specifically
regulated in the free market through supply and demand. That is, they do not correspond to
political decisions (directly), but only to the operation of the laws of supply and demand, and
which generally have an impact on sales strategies and company valuations.
In the face of market risk, companies or the public do not need to panic and immediately
withdraw their investment funds because the decline in assets does not apply continuously or is
only temporary. Therefore, losses incurred due to asset decline are only as a potential loss as
long as investors do not realize or sell their mutual funds.
In addition, there are several important things that need to be done in resolving market risk,
namely:
1.
Avoid market risk, if the risk is still under consideration to take, for example because it is
not in the risk category that the company wants or because the possibility is far greater than
the greater benefit.
2.
Accept and maintain, if the risk is at a more economical level.
3.
Raised, lowered, or eliminated if the risk can be controlled by good governance or through
the operation of an exit strategy.
Key Points:
Some important points to note in market risk management. Because it can affect the entire
market simultaneously, and it can also be turning off investors who ignore market risk when
building their businesses.
There are two components used to measure the maximum potential loss in a portfolio, namely:
1.
The time frame is the duration for which the market risk premium is calculated, basing the
confidence level on the investor's comfort level. Translated in %. For example terms like
95% or 99%. Simply put, the confidence level determines how much risk an investor or a
company can take.
Such a concept is a statistic and therefore the calculations are very heavy. Various tools
/ The mechanisms used for calculation are - Expected risk value shortfall, variance-
covariance, historical simulation, and monte Carlo simulation. Since market risk affects the
entire investor community regardless of their credibility or the asset class they operate in, it
is closely monitored by regulators around the world.
2.
The Basel Standard is a regulatory standard issued by the Basel Committee on Banking
Supervision (BCBS), one of the committees within the Bank for International Settlements
(BIS) that plays a role in setting banking regulatory standards and as a forum related to
banking supervision. This body also plays a role in overseeing changes that occur in the
banking industry and financial markets including the financial crisis that occurred in
Southeast and South Asia in 1997-1998, and the global financial crisis that occurred in
2007-2009. Starting from 2010 Basel is a regulatory reform in the banking sector in
response to the 2008 global financial crisis caused by the lack of capital evaluation,
variations in RWA between banks, very high leverage and also because of the liquidity
crisis.
LIQUIDITY RISK
Introduction
Bank operations will run well if it has sufficient working capital. The working capital will be
used for operational activities and payment of company obligations such as payment of salaries,
debts and other bills (Ulul Hidayati, 2017). If one of the items above cannot be fulfilled, the
company will experience financial difficulties. In economics, this condition is called illiquidity.
A company is said to be liquid or safe if it has a high level of liquidity (Sari & Badjra, 2016).
Liquidity refers to the amount of cash and other assets that can be directly converted into cash.
Liquidity is also the Bank's ability to fulfill its financial obligations when due (Dewi, 2016).
Banks that have sufficient liquid funds to fulfill all financial obligations that must be met
immediately are said to be liquid, and vice versa. on the other hand, the high liquidity of the
Bank has a bad impact. The accumulation of unused working capital (idle funds) causes funding
sources to be wasted and ineffective, because of the opportunity to raise funds maximum profit
will be lost (Notoatmojo, 2018).
In the economic system, banks are an important part of the financial sector. As an embodiment of
an intermediary institution, the Bank will channel loans to the public (when viewed from the
company's asset side), and on the liability side will provide liquidity (Sumartik & Hariasih,
2018). In addition, the Bank also creates favorable payment conditions, supports the smooth flow
of goods and services, and invests in production capital to stimulate economic growth and the
development of new industries. Thus, employment will open up and increase economic growth
(Sumartik & Hariasih, 2018).
However, the Bank's function has resulted in liquidity risk, which makes it difficult for the Bank
to fulfill its maturing obligations. It is feared that the Bank's liquidity ratio will not be able to
cover operational activities. Liquidity ratio itself is the company's ability to pay off all its short-
term financial obligations that are due (Perminas, 2017).
To overcome liquidity problems, good Liquidity Risk Management is needed. Liquidity risk
management is considered important because liquidity pressures in financial institutions can
affect the entire economic system. A well-performing and well-organized bank requires stable
liquidity risk management, due to many people losing confidence in the existing banking system
(Dewi, 2016). Effective liquidity risk management will ensure the bank's ability to meet its cash
flow obligations (Sultoni & Mardiana, 2021).
Definition of Liquidity Risk:
Liquidity risk is the Bank's inability to generate cash flows from earning assets, liquidation of
assets, raising public funds, interbank transactions and loans received (Indonesian Bankers
Association, 2015). Bank liquidity risk can also arise from a mismatch between the demand and
supply of funds. From the capital side, the Bank's liquidity comes from debtor deposits, credit
payments, loans from the capital market, interest income on loans and non-interest income on
loans, and the sale of Bank assets. On the demand side, liquidity comes from loan withdrawals,
loan applications, interest and non-interest expenses. The gap between supply and demand must
be maintained so that liquidity risk can be minimized (Ichsan, 2013).
The causes of liquidity risk according to (Bank Indonesia, 2009) are as follows:
1.
The company's assets (especially illiquid ones) are unable to generate income, both when
they are owned (purchased) and when they are resold.
2.
When managing loans, the Bank cannot generate cash flows.
If a bank is unable to meet its liquidity needs, public confidence will decline. In addition,
liquidity problems can affect other financial aspects and threaten the Bank's operational viability.
Given that liquidity problems can have a significant impact, banks must implement effective
liquidity risk management, both individually and together with subsidiaries (Indonesian Bankers
Association, 2015).
Liquidity Risk According to Basel III
Basel III is essentially a reform implemented by the BCBS (Basel Committee on Banking
Supervision) to make the banking sector more resilient. It states that banks take risks to improve
their performance. Basel III is a revision of Basel II and includes precautionary measures to
avoid a banking crisis.
According to Basel III regulations, liquidity management is assessed based on two approaches,
namely: (Indonesian Bankers Association, 2015).
1.
Liquidity Coverage ratio (LCR), which is the ratio of liquid assets to net cash outflows in a
30-day period. This ratio must be greater than 100%.
The LCR regulation requires banks to hold quality liquidity instruments within 30 days, in
anticipation of net cash outflow requirements.
The following is the formula for calculating LCR: (Financial Services Authority Regulation
no 42/POJK.03/2015, 2015)
2.
Net Stable Funding ratio (NSFR), is the ratio of stable funding to stable funding required.
This ratio must be greater than 100%.
This NSFR-related regulation requires each bank to provide stable funding in the form of
liabilities and equity, to fund its asset activities and managed accounts. In other words,
banks are required to establish a time horizon for the repayment of funds along with a time
horizon for the source of funds. If the bank plans to raise long-term funds, it should also use
long-term funds.
The following is the formula for calculating NSFR: (Financial Services Authority
Regulation Number 50
/POJK.03/2017, 2017)
Basically, the implementation of LCR and NSFR indicates that all banks are required to provide
funding sources and payments at the same time. The relatively short-term sources of third-party
funds (DPK), which previously had a maturity of one month, are gradually converted into long-
term sources of funds with a minimum maturity of one year (Indonesian Bankers Association,
2015).
With the introduction of the two new liquidity models (LCR and NSFR), banks need to conduct
more professional asset and liability management (ALMA). Good ALMA ensures proper
management of resources, use of funds, and does not reduce opportunities to grow the business.
In addition, fund transfer pricing (FTP) will be enhanced to facilitate the balancing of resources
and use of funds (Indonesian Bankers Association, 2015).
Liquidity Risk Indicators:
According to (Elfahdli, 2012), the indicators in assessing liquidity risk are as follows:
1.
Accuracy of cash flow planning based on funding forecasts and cash growth projections
(including cash volatility monitoring).
Bank management must be able to estimate the need for funds so that liquidity needs will be
maintained. If this estimate misses or something happens in the middle of the road, then
management must quickly revise its needs so that liquidity needs are maintained.
2.
Accuracy of funding structure management and adequacy of non-PLS funding (profit and
loss sharing).
It aims to avoid credit concentration, loans with unpredictable risks, and loans to saturated
sectors of the economy. In addition, credit diversification allows banks to manage their
banks effectively, maintain loan volumes and generate returns commensurate with their level
of risk (zahra & rizal, 2020).
There are three main principles in any loan portfolio or diversification: high risk, high
return, time value of money and never keep money in one portfolio. Basically, all these key
principles aim to reduce or eliminate potential risks when providing credit or financing
(zahra & rizal, 2020).
3.
Availability of assets that can be immediately converted into cash.
The composition of liquid assets also greatly affects the liquidity of the Bank. The more
liquid a bank's assets are, the less likely liquidity risk will occur because they can be
converted quickly into cash.
4.
Ability to access the interbank market or other funding sources (including lender of last
resort).
Management must be able to attract as many investors as possible. In addition, management
must also be able to find alternative sources of funding other than third party funds. For
example, by increasing the composition of shareholders, increasing company dividends and
borrowing from financial markets and capital markets.
Types of Liquidity Risk:
According to the Risk Management Certification Board, as adapted by (Surmadewi & Saputra,
2019), the types of liquidity risk are as follows:
1.
Endogenous liquidity.
This liquidity is inherent in the asset itself, and refers to the bank's ability to sell the asset
quickly and at a low bid-ask spread in a liquid market, regardless of the size of the
transaction.
2.
Exogenous liquidity.
Also called funding liquidity, it is the liquidity of the bank's liability structure. Banks can
use liquidity mismatches to identify funding mismatches.
Liquidity Risk Management:
Liquidity risk management is a very important issue in the banking industry, and is an important
part of the risk management framework of financial institutions. Banks often face the difficult
situation of having to respond promptly to customers' withdrawal needs, but on the other hand
banks must simultaneously use this source of capital to generate profits, pay costs, invest and
invest operating expenses (Indonesian Bankers Association, 2015).
Liquidity risk management is a key principle of the banking system. The liquidity situation that
occurs in a bank affects the entire system. Therefore, liquidity policymaking and liquidity risk
management are important elements of business strategy (Indonesian Bankers Association,
2015).
1.
Liquidity Risk Management Objectives
Obtaining sources of cash flow is the primary objective of liquidity risk management. In
addition, liquidity risk management aims to: (Farid & Azizah, 2021)
a.
Maintain adequate bank liquidity so that bank debts can be repaid when due.
b.
Maintain adequate bank liquidity to support sustainable growth of bank assets.
c.
Maintain optimal levels of bank liquidity to keep liquidity management costs
reasonable.
d.
Maintain customer confidence in the banking system
The bank chooses three liquidity management strategies, namely asset liquidity
management, debt liquidity management and balanced liquidity management. In liquidity
management, banks use one of the three strategies. When a bank uses asset liquidity
management, it holds cash during times of positive liquidity and uses that cash during times
of negative liquidity. Liquidity management liabilities include borrowing from banks to
cover liquidity shortfalls. Balanced liquidity management means combining asset and
liability strategies in liquidity management. Ultimately, the Bank will choose a strategy
based on the advantages and disadvantages of the strategy. (Susantun et. al, 2019)
2.
Risk Management Process
According to (Indonesian Bankers Association, 2015), the risk management process consists
of:
a.
Liquidity risk identification
In this phase, current and future liquidity is identified and conducted on a regular basis
by analyzing all sources of liquidity risk.
b.
Liquidity risk measurement
In this phase, liquidity risk measurement is tailored to the risk profile and complexity of
the bank's business. Thus, a dynamic approach and simulation will be conducted.
c.
Liquidity risk control
In this phase, the certainty of the fulfillment of the Bank's liquidity in anticipation of
sudden and unscheduled withdrawals is good. Banks are required to identify, measure,
monitor, and control in managing liquidity.
Relationship between Liquidity Risk and Profitability:
In theory, good liquidity risk management will improve the Bank's performance. This is due to
the availability of sources of funds for operational activities.
Thus, investor and depositor confidence will increase. This statement is proven in research
(Desiko, 2020; Mariana & Manda, 2021; Murtini & Sisnuhadi, 2018; Ramadanti & Meiranto,
2015; Silitonga & Gusganda Suria, 2022) which states that liquidity risk has a positive effect on
bank performance. The better the liquidity risk, the better the Bank's performance.
However, the opposite result is obtained (Erawati & Teguh, 2020; Fadriyaturrohmah & Manda,
2022; Korompis et al., 2020) which states that liquidity risk has a negative effect on
performance. The higher the liquidity risk, the lower the bank's performance.
From the two different research results above, it can be concluded that whether or not liquidity
risk is good depends on how well the utilization of available funds is. The high number of idle
funds is theoretically not very profitable because the Bank loses the potential to earn profits.
Although the availability of funds is sufficient to maintain the liquidity ratio, if the funding
strategy is not good, the results will not be maximized.
Conclusion:
The availability of liquidity in running company operations is absolutely necessary. The process
of identification, measurement and control must be carried out as well as possible so that the
company's liquidity can be maintained properly. Learning from the cases that have occurred, the
implementation of Basel III rules that have been validated by the Financial Services Authority
(OJK) regulations in the Bank must be obeyed. If not, public confidence will decrease and make
investors reluctant to invest.
OPERATIONAL RISK
Introduction:
In the beginning, a business will always face two aspects of risk, namely business risk &
financial risk. Business risk is the risk experienced by the company when operating, especially
with regard to the stability of the company's income. Meanwhile, financial risk is the risk of
financing the company including debt in the form of foreign exchange. The development of
technology, time and knowledge, especially in the aspect of risk, has caused business risk to
evolve, namely risks involving internal operations & external operations. Business risk is a risk
that involves operations outside the company that are related to the risk of sales or results
obtained by the company. Internal risks related to business are operational risks such as:
technological risk, legal risk and from various aspects that can be distinguished according to the
company's business activities in order to operate properly.
If you look at the company's daily activities regarding the existence of three risks, namely Credit
Risk, Market Risk and Operational Risk, then the loss from operational risk is
second only to credit risk. Market risk is second only to operational risk. Therefore, handling this
operational risk is very important for the company for efficiency.
Material Details
1.
Operational risk concept
The Basel Committee on Banking Supervision (BCBS) defines Operational Risk as:
"The risk of direct or indirect loss resulting from inadequate or failed internal processes,
people, and systems, or from external events."
The definition includes legal risk but excludes strategic and reputational risk. Hoffman
(2002) defines operational risk as follows:
The risk of loss from business disruption, control failures, errors, misdeeds, or external
events.
King (2001) defines operational risk as follows:
Operational risk is concerned with adverse deviation of a firm's performance due to how the
firm is operated as opposed to how the firm is financed. It is defined as a measure of the link
between a firm's business activities and the variation in its business results.
Operational risk can be divided into several groups with categories, namely:
a.
Operational risk is the risk that inefficiencies in information systems and internal
controls result in losses. This risk can be divided into the risk of fraud, the risk of
submitting incorrect information, the risk that cannot be controlled.
such as flooding and personal risk.
b.
Legal Risk is the risk that contract conditions cannot be carried out because, not written
in the agreement or in connection with applicable documentation and procedures. The
actions of employees who commit unlawful acts which expose the company to
penalties.
c.
Reputation risk is the risk of making contract provisions that will result in losses to
other parties so that the reputation of the company decreases to the company's
consumers.
d.
Accounting risk is the risk that errors in accounting practices that result in the
recalculation or restatement of earnings affect investors' views of the company.
e.
Funding liquidity risk is a risk that makes the company have to pay higher than the
market interest rate on its funding because investors' perception of the institution's credit
quality is decreasing and there is a large enough use of funds that the company is
increasingly considered not to be given again when it needs funding.
f.
Enterprise risk is the risk of loss that results from changing the entire habit or culture
(climate) of the company such as customer needs, competitor actions, and rapidly
evolving technological innovations.
However, it has been explained in the concept conveyed by BCBS that reputation risk is not
included in operational risk, even reputation risk is a separate risk. This is because reputation
comes from outside the company, which is the perception of outsiders towards the company.
Legal risk can be included in operational risk. Therefore, only defining operational risk is a
risk that comes from within the company.
2.
Identification of operational risks:
One of the stages in overcoming risk is recognizing the risks that the company will face or
called risk identification. Some parties mention that this risk identification is an initial action
that provides input to all parties to measure, monitor and control risks. The better the risk
identification action, the better the next stage will be.
In identifying risks, it is necessary to first categorize the risks that will occur from internal
and external companies. Risks that occur internally can generally be controlled and quickly
overcome, even recognized. While operational risks originating from external sources are a
little difficult to identify but can be done but require a long time and thought. In identifying
operational risks, it can be found that the risk is qualitative or quantitative. Generally,
quantitative risks are preferred because they are easier to interpret. Meanwhile, the risk of
Qualitative operations are very difficult to interpret. This qualitative risk is converted into
quantitative form to make it easier to describe and measure it. Qualitative risks that are
converted to quantitative risks require time and deeper and broader knowledge.
The Bank for International Settlements (BIS, 2004, p. 140) categorizes operational losses
into seven loss event types, namely:
a.
Internal fraud.
b.
External fraud
c.
Employment practices and workplace safety
d.
Clients, products, and business practices.
e.
Damage to the company's physical assets (physical asset damages).
f.
Business disruption and system failure
g.
Product and service execution, delivery and process management.
The BIS categorizes the 7 identified activities into operational risk, but it may differ from
the BIS especially for developing countries. It should be noted that legal risk is part of
operational risk according to the BCBS described in the previous concepts and definitions.
Understanding the risk identification will lead to the method used to measure the operational
risk.
3.
Measurement of operational risk:
Companies must be able to manage operational risk because operational risk will generate
efficiency for the company and will improve company performance as the ultimate goal of
managing this risk. On the other hand, the inability of the company to manage operational
risk will result in the company experiencing losses and will have an impact on the
company's capital (Capital). If the company's capital is getting smaller, the sustainability of
the company will be increasingly unclear. There are several benefits obtained if the company
can manage operational risk, namely:
a.
Avoid unexpected losses and improve operational efficiency.
b.
Efficient use of capital.
c.
Provide satisfaction to stakeholders.
d.
Meet regulatory demands.
The benefits obtained from risk management will make the company's performance better.
Operational risk measurement can be done by several methods but the Basel Committee on
Banking Supervision (BCBS) mentions two approaches to operational risk measurement,
namely the standard method approach and the internal method approach. The standardized
method approach includes three methods, namely:
a.
Basic Indicator Approach (BIA) Method,
b.
Standardized Approach (SA)
c.
Alternative Standardized Approach (ASA).
While the measurement of operational risk with an internal approach is known as the
Advanced Measurement Approach (AMA).
The Basic Indicator Method, Standardized Method and Alternative Standardized Method
can be called the Top-down Approach, while the Advanced Measurement Approach is called
the Bottom-up Approach.
The Basic Indicator approach is the simplest approach among others, where gross income is
referred to as a proxy for the scale of operational risk exposure at the bank. Gross income is
the net interest income and non-interest income of the company or bank concerned.
Where:
GI = gross revenue
n = the sum of the previous three years of positive GIs
𝛼 = fixed percentage for the previous three years of positive GIs
There are four reasons for using this approach:
a.
Very simple to calculate
b.
It does not require time and resources in order to develop more complex model
alternatives.
c.
Very useful in the early stages of Basel II implementation especially when loss data is
not available.
enough to build more complex models
d.
Especially useful in small and medium-sized banks.
Standardized approach, which is a higher level approach than the Basic Indicator approach
by taking into account the types of business of the bank concerned. Gross profit is the most
widespread indicator as a proxy for the scale of business operations and operational risk
exposure. Under the Standardized approach, gross profit and beta of each business unit are
required to calculate its operational risk.
Where: β = fixed percentage determined by the bank committee
Alternative Standardized approach is a method that is almost the same as the Standardized
approach. The calculation of capital charges has separated the bank's retail business unit and
the bank's commercial business unit. But the calculation does not use gross income but from
the average total loans and advances for the last three years.
Usually these approaches are almost equal in magnitude.
The Internal Measurement approach, is the simplest of the Advances Measurement
approaches in the internal approach. In calculating the capital charged as operational risk,
there are 3 parameters that must be considered, namely:
The Exposure Indicator (EI) is usually assessed by gross revenue; there are Probability of
Event (PE) and Loss Given Event (LGE) and these three are multiplied by considering an
unexpected loss scale symbolized by γ. This approach uses the following calculation:
𝑛 𝑘
𝐾𝐼𝑀𝐴 = ∑ 𝛾𝑖,𝑗𝐸𝐼𝑖,1 ∗ 𝑃𝐸𝑖,𝑗 ∗ 𝐿𝐺𝐸𝑖,𝑗
𝑖=1 𝑘=1
The value of γ is determined by the bank committee for each business unit and operational
risk event type.
Risk Operational At Business Micro Small and Medium Enterprises:
Definition
According to the Government of the Republic of Indonesia Law No. 20/2008 on Micro, Small
and Medium Enterprises, defines MSMEs as:
1.
Micro Businesses are productive businesses owned by individuals and/or individual business
entities that meet the criteria of Micro Businesses as stipulated in this Law.
2.
Small Business is a stand-alone productive economic business, conducted by individuals
and/or business entities that are not subsidiaries or branches of companies that are owned,
controlled, or are part directly or indirectly of Medium Enterprises or Large Enterprises that
meet the criteria of Small Business as referred to in this Law.
The Ministry of Cooperatives and Small and Medium Enterprises (Menengkop and UMKM)
defines Small Enterprises (SEs) including Micro Enterprises (UMIs) as business entities that
have a net worth of at most IDR 200,000,000 (excluding land and buildings of the business
premises) and have annual sales of at most IDR 1,000,000,000. while Medium Enterprises
(UMs) are business entities owned by Indonesian citizens that have a net worth of more than IDR
200,000,000 - IDR 10,000,000,000 (excluding land and buildings of the business premises).
The existence of MSMEs has very clear benefits for the economy in Indonesia. Indonesia was
able to survive the global crisis that occurred in early 2008 due to the existence of MSMEs. In
addition, MSMEs are the most potential source of economic development in Indonesia.
Therefore, it is necessary to increase the empowerment of MSMEs that are easily available and
accessible, operational management assistance and the role of government institutions and the
role of universities.
However, in running their business, MSME owners will certainly face risks that may occur as a
result of their activities in running their business. Some of the risks that can occur in MSMEs,
especially those experienced by developing countries such as Indonesia, include:
1.
The lack of raw materials means that they have to be imported from abroad.
2.
Lack of marketing.
3.
Lack of capital.
4.
Lack of availability of energy, infrastructure and information.
In addition, problems such as inflation are also often experienced by developing countries in
ASEAN, including Indonesia.
When viewed from various aspects, the risks experienced by many MSMEs in Indonesia are as
follows:
1.
Production Aspects
Risks that can arise from the production aspect are the acquisition of the quality and quantity
of raw materials from suppliers and the origin of the raw materials. In addition, it is also
necessary to consider the selection of appropriate technology and techniques in processing
these raw materials. This is used to consider the time and costs that must be paid to carry out
an effective and efficient production process.
2.
Human Resource Aspects
The risk that can arise from the Human Resources (HR) aspect is the origin of the HR. This
is used to consider the amount of salary that must be spent.
3.
Capital Aspects
The risk that can arise from the capital aspect is the ability of MSMEs to pay their business
costs or debts from their business. This is used to consider financial spending effectively and
efficiently.
4.
Marketing Aspects
Risks that can arise from the marketing aspect are marketing systems that are carried out
online or offline. This is used to consider MSMEs in facing the digitalization era.
5.
Legal Aspects
Risks that can arise from the legal aspect are the legality of the products and business
licenses of these MSMEs. This is use to consider the exact development and expansion of
the MSME.
Summary:
Operational risk is the risk that inefficiencies in information systems and internal controls result
in losses. This risk can be divided into fraud risk, risk of submitting incorrect information,
unavoidable risks such as flooding and employee risk (personal risk).
Operational risks can be divided into several groups with categories, namely:
1.
Legal Risks
2.
Reputation risk
3.
Accounting risk
4.
Funding liquidity risk
5.
Enterprise risk
The Bank for International Settlements (BIS, 2004, p. 140) categorizes operational losses into
seven loss event types, namely:
1.
Internal fraud.
2.
External fraud
3.
Employment practices and workplace safety
4.
Clients, products, and business practices.
5.
Damage to the company's physical assets (physical asset damages).
6.
Business disruption and system failure
7.
Product and service execution, delivery and process management.
There are several benefits obtained if the company can manage operational risk, namely:
1.
Avoid unexpected losses and improve operational efficiency.
2.
Efficient use of capital.
3.
Provide satisfaction to stakeholders.
4.
Meet regulatory demands.
Operational risk measurement can be done by several methods but the Basel Committee on
Banking Supervision (BCBS) mentions two approaches to operational risk measurement, namely
the standard method approach and the internal method approach. The standardized method
approach includes three methods, namely:
1.
Basic Indicator Approach (BIA) Method,
2.
Standardized Approach (SA)
3.
Alternative Standardized Approach (ASA).
While the measurement of operational risk with an internal approach is known as the Advanced
Measurement Approach (AMA).
1.
Micro Businesses are productive businesses owned by individuals and/or individual business
entities that meet the criteria of Micro Businesses as stipulated in this Law.
2.
Small Business is a stand-alone productive economic business, conducted by individuals
and/or business entities that are not subsidiaries or branches of companies that are owned,
controlled, or are part directly or indirectly of Medium Enterprises or Large Enterprises that
meet the criteria of Small Business as referred to in this Law.
Some of the risks that can occur in MSMEs, especially those experienced by developing
countries such as Indonesia, include:
1.
The lack of raw materials means that they have to be imported from abroad.
2.
Lack of marketing.
3.
Lack of capital.
4.
Lack of availability of energy, infrastructure and information.
When viewed from various aspects, the risks experienced by many MSMEs in Indonesia are as
follows:
1.
Production Aspects
2.
Human Resource Aspects
3.
Capital Aspects
4.
Marketing Aspects
5.
Legal Aspects
CASE STUDY OF OPERATIONAL RISK OF SAMARINDA CITY
Introduction:
UMKM Gorden Getol is a conventional business that produces curtains, tablecloths, TV cloths,
gallon cloths, etc. This UMKM was established in 2012 on Jl. Provinsi Gg. Lestari RT 04
Makroman Village, Sambutan District, Samarinda City. The name of this business comes from
the word getol which means superior.
Methods:
The type of research used in writing this case study is a qualitative research method by means of
description in the form of words and language. The author conducted an interview with the
owner of the "Getol Curtains" business to obtain materials for further processing. The data
obtained is then analyzed and presented in paragraph form which is then included in the
discussion section. In this case, the author tries to study the risks in MSMEs "Getol Curtains".
The research location is in RT.04 Makroman Village, Sambutan District, Samarinda City.
The research data was obtained from primary data sources obtained from the first party or the
source directly, namely Mrs. Siti Rohanah as the owner of the "Getol Curtains" business. The
data collection techniques used are observation, interview, and documentation. Observation The
interviews were conducted through direct observation at the location where the curtain making
process was carried out. Interviews were conducted to extract information and data from
informants regarding the topic under study, namely MSME risks based on questions that had
been prepared by the researcher.
Discussion:
Based on the results of data collection obtained using the interview method to MSME actors, the
authors then analyzed the data so that the factors causing the risks of UMKM Gorden Getol were
obtained. When viewed from various aspects, the risks that are mostly experienced by UMKM
Gorden Getol are as follows:
1.
Production Aspects
Risks that can arise from the production aspect are the lack of equipment in the curtain
production process, for example a steam iron. In addition, the raw materials obtained are of
good quality, however, the raw material supplier is far from the business premises, which is
at Toko Piala Samarinda.
2.
Human Resource Aspects
Risks that can arise from the human resources aspect are the lack of manpower in carrying
out the production process due to the age of the UMKM owner who is elderly. In addition,
UMKM Getol Curtains is an independent business and does not have a single employee.
3.
Marketing Aspects
Risks that can arise from the marketing aspect are the lack of marketing done offline, i.e.
there are no brochures or catalogs that can be distributed to potential customers. In addition,
most customers of UMKM Getol Curtains are not from the Makroman area itself, but from
outside the city.
4.
Legal Aspects
Risks that can arise from the legal aspect do not exist, because Getol Curtains MSMEs
already have the legality of the products and business licenses of these MSMEs, namely
IUMK (Small Micro Business Permit).
