Risk is a part of almost everything we do in life, including the day-to-day operations of a business. Learning to assess risk and apply mitigation strategies can help businesses minimize the noticeable impact on their bottom line and reputation. Learn what operational risk entails, its dangers, how to identify indications of risk, and how RiskRecon can help minimize your likeliness of operational risk.
What Is Operational Risk?
Operational risk is the inherent possibility of financial loss or poor performance due to the mismanagement of resources or processes. There are a few different types of operational risk to know, including:
People risk
Businesses of all sizes risk losses due to poor human resource abilities and policies, thus affecting attracting, hiring, managing, training, and retaining staff. The risk of people also includes human error, lack of motivation, ethical concerns, and fraud. Human error is the most common cause of operational risk.
Systems risk
Ineffective and disorganized business systems can lead to operational losses and give others a competitive advantage. This includes operational risk events like outdated software or hardware, unsecured networks, or cyber threats. Failing to follow cybersecurity best practices can lead to systems risks.
Process risk
Operational risk may also include challenges within business processes, including policies, risk monitoring tools, or supply chain logistics. Human or computer error during business operations can affect the day-to-day of the business.
External events risk
External events outside a business's control can also lead to business risk. This may include natural disasters that prevent shipping or geopolitical concerns that affect a brand's reputation. External events can also cause market risk, affecting the potential risk of whole industries.
Legal and compliance risk
There is also the risk of legal and compliance issues, which could lead to expensive fines and penalties. Legal and compliance risks may involve regulatory changes, banking supervision requirements, or credit risks.
The Basel Committee on Banking Supervision (BCBS) defines operational risk in Basel II and Basel III as a loss that results from inadequate or failed internal processes, people, systems, or external events.
An example of operational risk: Employees access their work database using their laptop while at home, exposing the system to cyber risks. Risk managers later notice the operational risk exposure after unauthorized users gain access to the database. This is an example of both people and systems operational risk since a lack of training and secure systems led to an increased risk profile.
Dangers of Operational Risk
Operational risk carries many dangers, including:
- Employee shortages
- Employee retention issues
- Lack of customers
- Poor company reputation
- Financial risk of losses
- Business failure
- A data breach that leads to a loss of data or internal control
- Disruption of business processes
- Internal and external fraud
- Systems failures
- Lack of business continuity
- Lack of sustainability
- Expensive fines following compliance or legal issues
- Loss of business licenses in financial institutions or financial services
Consequently, assessing and minimizing operational risk can help businesses avoid disruptions, protect their image, prevent compliance and legal issues, and keep their revenue positive.
Why Is Operational Risk So Common?
Human error is the primary reason for high operational risk levels in an organization. Most businesses are comprised of many employees at all levels, including support-level staff, management, decision-makers, and owners: the larger an organization, the greater need for risk management strategies.
How Can You Identify Operational Risk?
Identifying and assessing operational risk can help you decrease its impact. Setting key risk indicators and automating the process of data collection ensures you identify operational risks in a timely manner. Anticipating operational risks through risk assessment and scenario analysis can help businesses pinpoint their most significant vulnerabilities before they occur.
A few key ways to identify operational risk include conducting frequent internal audits, frequently reviewing your business's processes, and determining your risk appetite.
How To Minimize and Overcome Operational Risk
While it's not possible to fully prevent all risks, it is possible to minimize them. Risk mitigation can be achieved using the following four important principles of operational risk management:
- Only accept risk when the benefits outweigh the cost
- Avoid taking on any unnecessary risk
- Anticipate and manage risk by planning ahead
- Make risk decisions at the right level
Mitigating risk requires a thorough operational risk assessment that considers all operational risks. By anticipating risks and then categorizing them into key risk levels, including strategic, deliberate, and time-critical, organizations can assign the most effective integrated risk management strategies to the problem.
Overcoming Operational Risks Tips
Businesses can implement strategies to control the most prominent risks. Here are a few tips to assist with operational risk management:
Determine Who Controls and Influences Operational Risk
Typically, senior management or the board is in charge of controlling and influencing operational risks. Senior managers or operational risk officers can use resources to model risk and predict the potential impact of different loss events on the overall processes of the business. They can then use the data available to implement risk management strategies.
Learn To Predict Probability
Assigning risk assessment codes to specific operational risks can help businesses predict their probability. Pairing probabilities of operational risks with the likely severity of their effect can also help businesses put the right safeguards in place. Setting key risk indicators can also help businesses more accurately predict operational risks.
Learn To Weigh Cost With Risk
Some risks may not be worth the cost or resources put into preventing them. Setting risk tolerance thresholds can help organizations decide which operational risk management strategies to focus on. Reviewing potential risks in line with the business's goals is one of the most important steps in managing risk and can also help businesses create the best risk management protocols based on their unique needs.
Continually Monitor Risk Management Strategies
Risk management should also include continual monitoring. An automated process may help manage enterprise risk management needs. Routine monitoring also allows businesses to monitor the effectiveness of existing risk management solutions while also recognizing any residual risk factors to consider.
How RiskRecon Can Help
Operational risk is present in most business industries. RiskRecon, a Mastercard company, can help you assess and predict risk and identify your organization's best operational risk management strategies. You need access to accurate, comprehensive data to assess and mitigate risk properly. Contact us today to find out how we can provide you with actionable data and analytics that make it easy to readily and thoroughly assess and respond to operational risk within your own business. RiskRecon can also set your business up with cybersecurity solutions that can safeguard you against operational risks at the systems and processes levels.
Operational risk is inherently common in businesses, mostly due to human error. However, no business is immune to the dangers of operational risk. Whether from inefficient internal policies or unsecured technology networks, operational risk is always present. Learning to identify common risks and setting safeguards against them can help minimize the impact on your business.
