How does the pandemic change operational risk? Evidence from textual risk disclosures in financial reports

Abstract

This paper studies how the Covid-19 pandemic changed the operational risk profiles of the financial industry. We find that the textual risk disclosures in financial reports contain abundant information on operational risk. A text mining method is introduced to analyze changes in operational risk in an innovative way based on a massive textual data set of financial institutions’ textual risk disclosures, which aggregates senior managers’ risk perceptions of the whole financial industry. Based on 4624 financial reports released by 1330 financial institutions from 2017 to 2020, this empirical study finds that operational risk remained the most prominent major risk type after the outbreak of Covid-19, and that disclosures of operational risk increased by 5.19% compared with the samples from before the outbreak. The drivers of operational risk also changed, with significant increases in disclosure of litigation risk, transaction modes and product and service problems as a proportion of total disclosures. In addition, two emerging operational risk drivers identified during the pandemic are data safeguarding and goodwill impairment. Our findings could help financial institutions and regulators to identify and manage the critical drivers of operational risk during a future pandemic.

Keywords: operational risk, Covid-19, text mining, risk factor, Form 10-K