The financing of operational risk is based upon the premise that any organization of a certain size will pay for its operational losses either by purchasing insurance or by totally self-insuring. Eventually insurance costs will adjust to pay for actual incurred losses. There is a clear and direct relationship between insurance premiums and actual losses which may be tracked over a period of time (generally three to ten years). Consequently, some organizations decide to underwrite the risk themselves by not insuring with external parties. The exception to this theory is the random catastrophic loss (or "long tailed risk") which occurs rarely, if ever. Even in self insured programs, insurance is purchased or should be purchased to cover these "long tailed risks" The retention of risk is most appropriate for low cost/high frequency losses. Some unsophisticated buyers purchase insurance only for smaller losses. This is both an extremely uneconomical method of financing small losses and exposes the organization to potentially catastrophic losses. Once management realizes that the organisation will ultimately pay for its own losses, risk identification and risk control will become paramount in managing risk.

Even in "insured" programs there is a strong element of self insurance. This becomes more predominant for those risks whose costs becomes higher as the size of the organization increases i.e. where insurance cover is generally reserved for catastrophic risks. Therefore, as the nature and the size of banks within the Kingdom changes, so too does the need to address the issue of self insurance.

Self insurance has three major advantages:

• -    Improved loss control as a result of increased risk awareness.

• -    Improved claims control.

• -    Cash flow benefits.

However, it also has two significant disadvantages:

• -    Financial instability in cases of poor budgeting/reserving.

• -    A need for increased management oversight and administration.

There are various forms of self insurance as given below: