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Determinants of Internal Fraud and Improper Business or Market Practices in Financial Institutions

With a focus on banks operating in German-speaking countries, we investigate whether operational losses resulting from internal fraud or improper business and market practices correlate with firm-specific variables or financial institutions’ business environment. Based on a multiple regression model, we find that the factors associated with operational loss severity vary across banks’ business lines and that respective regression coefficients sometimes even have opposing signs. In particular, an increase in bank staff is associated with lower operational losses in the “retail banking” subsample but higher operational losses in the subsample including all other business lines. Similarly, while after the introduction of the Basel II accord operational losses are lower in retail banking, they tend to be higher in the non-retail banking subsample. Finally, we observe a negative correlation between operational losses in non-retail business lines and both profitability and bank age. Overall, our findings shed new light on the determinants of operational losses in the banking industry, and they emphasize the importance of maintaining a business line-specific approach to operational risk measurement and management.