Operational risk management has been under the spotlight of regulators and businesses for many years now. In today’s uncertain operational environment marked by volatile business outlook, rising number of regulations and regulatory updates, and high costs of services, along with internal challenges such as operational lapses, internal fraud, and de-motivated employees, there is a clarion call for effective operational risk management by organizations.
This article provides a deep dive into operational risk management, why it is important for organizations, the key steps for successful implementation, the role of technology, and more.
Operational risk management (ORM) is the process of proactively identifying, assessing, mitigating, and monitoring risks that disrupt daily operations. These risks can be internal, such as people, processes, and systems, or external, like natural disasters or regulations.
An ORM exercise aims to understand the variables that may affect various aspects of the operational performance of an organization and take means to mitigate aspects that have the potential to create damage.
ORM helps businesses stay resilient. It should be an integral part of a business’s overall risk management strategy. An organization that understands the importance of this discipline will be able to take advantage of its benefits and minimize its costs by ensuring that all activities are performed within an appropriate framework. Further, when a risk does materialize, the organization will be able to recover quickly from its detriments and ensure business continuity.
Operational risk, in the context of risk management, has become more significant now than ever before. An effective ORM program, aligned with strategic business goals and objectives, is essential for an organization to stay resilient in today’s fast-changing risk environment. Here are a few reasons why ORM is important for businesses:
Operational risk is any type of business risk that can impact the failure of an organization’s internal processes, people, and systems. The term operational risk can also be used to describe any business activity where there is a potential for harm to employees, customers, and/or the community.
For example, fire hazards pose a risk to businesses as they can disrupt operations, damage property, and potentially cause injury or loss of life. Similarly, the risk of mis-selling, or the risk of employees or agents selling products or services to customers in a deceptive or fraudulent manner, can damage an organization's reputation and lead to financial losses or legal liabilities. Any such risks can have significant impacts on an organization if not properly managed.
Here are some examples of operational risk:
Operational risks can be broadly classified into five major categories, in the context of better mitigation.
People risk is the risk associated with the human resource employed at an organization and originates out of any actions or omissions committed by the workforce. The acts or omissions can be an individual or a collective effort. People risk seeks to understand the effects of the decisions taken by employees within the organization and their impact on the operations.
Process risk is the risk associated with several processes deployed by the organization. The risk originates from inefficiencies within the process that have the potential to cause detriment to operations and revenues of the organization. Process risk involves understanding the changes in processes, changes in the market concerning the processes, and changes in organizational culture with respect to the processes that can cause damage.
Organizational systems are complicated networks containing critical information about an organization. Therefore, systems risk is the risk associated with organizational systems that have the potential to create damage, extend unauthorized access, or delete critical business data.
External events risk encompasses all risks that originate and exist outside of the organization, but can have a direct or indirect impact on its operations. External events may originate from third parties, customers, competitors, and partnerships – bringing the risks associated with each of these entities to the organization’s operations.
Legal and compliance risks are risks associated with regulatory authorities, jurisdictions, and geopolitics of a particular market. These risks differ depending on the operating region and affect the organization differently in different areas. The risks typically involve the risk of changing regulations, policies, and new tax regimes.
Operational risk management is a complicated task for any organization. Since operations are several and complex, ORM has to deal with various challenges before it can yield results. Here are some of the most prominent challenges to ORM.
One of the most significant challenges to the ORM is the inability to detect new risks that arise in the operational environment. The purpose of an efficient ORM strategy is to mitigate all risks to the operations of an organization. However, with an ever-evolving market and a dynamic economy, it becomes difficult for organizations to keep up with the changing risk landscape – creating gaps in the risk management strategies and existing risks.
An organization’s ability to handle operational risk is only as good as its understanding of the risk. A common issue while assessing, preparing, and deploying strategies to combat operational risks is the lack of common ground between multiple entities involved in the process. While some parties within the organization may understand the risks to the same effect, others may comprehend it differently. Therefore, with lapses in a common understanding, the ORM exercise is likely to fail – largely due to inconsistent processes across various functions.
ORM is plagued with a lack of resources to deal with the risks that an organization faces. The ORM exercise is overlooked by organizations, with little attention and resources provided to the processes that help avert risks to operations. With limited resources and several complicated processes to develop, ORM becomes ineffective.
Operational risks are often intangible, and their consequences can be difficult to quantify. For example, the impact of a data breach on an organization's reputation may be difficult to quantify in terms of lost revenue or profits. Additionally, operational risks may have indirect impacts on an organization, such as reputational damage, that are difficult to quantify.
Operational risks often involve multiple data sources and systems, which can lead to data inconsistencies that make it difficult to accurately assess risks. Additionally, operational risks may be dynamic and constantly evolving, which can make it difficult to keep data up to date and accurate. This can make it challenging for organizations to effectively manage operational risks and make informed decisions about how to mitigate them.
Here are some of the key guidelines that can help organizations develop and implement an effective ORM program:
