Consistency of Risk Reporting in Financial Services Firms

Abstract

While there have been substantial developments in financial reporting over many years, the reporting of risk in statutory reports is still very much in its infancy. This comes at no surprise given risk is multidimensional and can be measured in many ways. In the financial services sector (FSS), where risk-taking is the fundamental business, the industry standard for risk disclosure is Value at Risk (VaR). This applies to a small proportion of FSS risk - this being market risk in trading activities. Although operational risk has been at the core of the collapse of a number of financial services firms over recent years, there are no formal accounting standard for operational risk. Further, the Basel Committee's requirements on operational risk disclosures (Pillar 3) are qualitative. This paper examines the nature of current operational risk disclosures by international banks, the consistency of disclosures, and their usefulness. The information is taken from the 2004 and 2005 annual reports of fifty-seven financial institutions. We find that the quantity and quality of operational risk disclosures vary significantly across institutions. The disclosures are predominantly descriptive and of qualitative nature - in order to be useful banks need to supplement their current disclosures with quantitative information. Due to the lack of consistency and the vagueness of disclosures it is not possible for external parties at this to compare the operational risk levels of banks.