The Impact of Bank's Internal Governance Mechanism on Operational Loss: Evidence from Turkey

Abstract

We study the impact of internal governance mechanisms on the operational risk management provided with deposit banks of Turkey as a Basel compliant representative banking system. Drawing from internal audit, internal control and risk management literature, we consider the impact of characteristics of these mechanisms on the degree of operational loss at the subcommittee level. Two factors stand out as improving the internal governance of banks. Internal governance quality improves resulting in less material operational loss with adequate staffing. Organization of the internal governance mechanisms, carefully structured control points and sufficient reporting to senior level management in banks ensure that banks’ shareholders experience fewer surprises. Excess funding has limited or no effect on mitigating operational loss. Characteristics are more significant for internal audit and internal control subcommittees than they are for risk management subcommittee. Results are robust when tests are repeated with aggregated data in order to capture potential cooperation between and contribution of the individual units.