Journal of Operational Risk

Xiaoqian Zhu

Welcome to the third issue of Volume 17 of The Journal of Operational Risk, which is a special issue titled “Impacts of Covid-19 on the operational risk of financial institutions”.

As far back as 2006, the International Monetary Fund pointed out that operational risk constitutes the greatest challenge to the global financial system in the event of a severe pandemic. Recently, the outbreak of a novel coronavirus (Covid-19) epidemic severely impacted the vast majority of financial institutions in many ways. It led to a brand new operating environment for financial institutions and was one of the biggest operational resilience challenges that financial institutions have encountered. The magnitude of the Covid-19 crisis is leading businesses to reevaluate their operational risk framework.

The Journal of Operational Risk, as the leading publication in the area, organized this special issue and is publishing the original papers that appear in it to discuss how the epidemic has impacted operational risk in financial institutions and what the potential solutions are. We hope that the research in this issue will lead to better understanding and management of operational risk arising from the pandemic, for practitioners, academics, policymakers and regulators.

In this special issue we have four very interesting research papers. The first is an enlightening paper that innovatively uses the textual risk disclosure data in financial reports to study how the Covid-19 pandemic has changed operational risk profiles. The second paper develops a new systems thinking model to describe the complex, adaptive nature of the actual evolution of Covid-19 and the implications of this model for operational risk management. In contrast to the first paper, the third paper uses quantitative data from financial statements to examine changes in operational risk and its determinants under Covid-19. The issue’s final paper focuses on the changes in the workplace that were triggered by the Covid-19 pandemic and proposes a behavioral approach to compliance risk management.

RESEARCH PAPERS

In this special issue’s first paper, “How does the pandemic change operational risk? Evidence from textual risk disclosures in financial reports”, Yinghui Wang, Yanpeng Chang and Jianping Li innovatively use a text mining method to analyze changes in operational risk based on a massive textual data set of financial institutions’ textual risk disclosures in financial reports. This research makes it possible to aggregate senior managers’ risk perceptions of the whole financial industry. Based on 4626 financial reports released by 1330 financial institutions between 2017 and 2020, they find that operational risk remained the most prominent major risk type after the outbreak of Covid-19, and disclosures of operational risk increased by 5.19% compared with samples from before the outbreak. They also identify two emerging operational risk drivers, ie, data safeguarding and goodwill impairment during Covid-19. Their findings could help financial institutions and regulators identify and manage the critical drivers of operational risk during the pandemic.

In our second paper, “Modeling systemic operational risk in the Covid-19 pandemic”, Patrick McConnell develops a new systems thinking model to describe the complex, adaptive nature of the actual evolution of Covid-19 and how interventions slowed that evolution before vaccines became available. The implications of this model for operational risk management are then analyzed, with a particular focus on developing pandemic risk scenario models to identify risks from emerging variants of the Covid-19 virus. The paper concludes by suggesting further research that could help identify how current and future pandemics might evolve and impact operational risk departments.

In the third paper in the issue, “Changes in operational risk and its determinants under Covid-19”, Zongrun Wang, Haiqin Fu and Ling Zhou examine the direct impact of the Covid-19 pandemic on the operational risk of Chinese commercial banks and look at the moderating effect of bank size, business diversification and regulatory records. Their empirical study uses 639 financial statements from 20 listed commercial banks in China from 2011 Q4 to 2021 Q3, and the authors find that the Covid-19 pandemic increased the operational risk of commercial banks, and that business diversification, bank size and a poor regulatory record significantly increased the operational risk effects of the pandemic. Their findings provide suggestions for banks on how to deal with and manage operational risk in a future pandemic.

In this special issue’s fourth and final paper, “The Compliance Index: a behavioral approach to compliance risk management in the (post-) Covid-19 era”, Sebastian Rick and Ralf Jasny present what they call the Compliance Index, which measures the legitimacy of organizations’ compliance programs for addressing the changes in the workplace triggered by the Covid-19 pandemic. They discuss the nature and purpose of the Compliance Index and explain the theory underlying their model. The paper’s main findings include that ethical leadership and compliance programs that focus on, for example, detecting misconduct, pursuing complaints or penalizing rule violations have a positive effect on the legitimacy of compliance programs.

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