Op Risk database reveals fraud costs

Fraud is a far greater operational risk than banks have been prepared to admit, according to data compiled by Aon, the insurance company.

Last month, Chicago-based Aon launched an operational loss risk database, Aon OpBase, which it says is the first commercially available database of op risk losses based on records of actual insurance claims, rather than just publicly reported losses, for example.

The database covers 12,000 risk events at 2,000 financial firms dating back 10 years, and throws up some sharp contrasts with the quantitative impact studies carried out by the Bank for International Settlements, which has been assessing the effect on banks of its proposals for a new Accord on regulatory capital – Basel II.

In particular, banks seem to have been reluctant to disclose details of frauds they have suffered, even privately, to each other.

The third and most recent Basel quantitative impact study – QIS3 – concluded that 98% of losses through fraud were for sums less than $1 million. But Aon says the mean size of bank fraud is $3.5 million. And that’s after stripping outlying mega-frauds, such as Nick Leeson’s and John Rusnak’s.

The reason for the different results, says Aon, is that banks don’t like reporting frauds if they don’t have to, and they certainly like to keep reports of their frauds away from the press, especially larger internal frauds. The average size of internal frauds reported by banks in QIS3 was $300,000, and $68,000 for external frauds. The Aon database finds the average to be $3 million and $1 million respectively.

The new AonOpbase will compete for attention with other op risk databases, such as those on offer from rating agency Fitch and systems and software vendor SAS. There are also some bank consortia projects, such as the Operational Risk Exchange (ORX) and the British Bankers’ Association database.

Under the Basel II regime, effective from January 1, 2007, banks will be encouraged to source external data on op risks before insuring themselves against risks or set aside appropriate levels of capital.

Aon aims to help financial firms understand how insurance prices respond to the cost of losses, says Jonathan Humphries, associate director at Aon Professional Risks in London. “You can’t expect the insurance industry to insure everything that can be classed as op risk,” he adds. “Individual banks can put the right controls in place once they fully understand the risk.”Risk