Understanding Operational Risk
Operational risk epitomizes the uncertainties and hazards that can ensue during the mundane day-to-day operations of a company. It’s like the underappreciated backup singer of the business risk band—essential but often overshadowed by its flamboyant lead, the market risk.
Unlike systematic risk that worries about macroeconomic clouds, operational risk is all about the storm brewing within, often brewed by the human elements within a company. Whether it’s a slip-up in data entry or a full-blown IT system meltdown, operational risk lurks in the shadows of every decision and action taken by a firm.
Key Aspects of Operational Risk
Operational risk is a chameleon in the business world; it changes colors according to the internal landscape of an organization. It’s rooted deeply in the activities that constitute a company’s day-to-day operations, from the monumental decisions by top management down to the mundane tasks carried out by frontline employees. Here’s a clearer drill down:
Human Factor
At its core, operational risk is predominantly about the ‘people problems’. From a fat-fingered typo to more egregious errors like fraudulent activities by staff, the human factor is often the Achilles’ heel in the armor of operational risk. To combat these risks, companies often dive deep into the HR toolkit, employing stringent hiring practices, continuous training programs, and sometimes, keeping motivational posters in hopes they do more than just adorn office walls.
Process Adequacy
Every company has a skeleton of processes and systems—some robust, others not so much. Operational risk assesses how these processes might fail, whether through inefficiency, obsolescence or malpractice. It’s like checking if the plumbing is sound in a beautiful house; if the processes are leaky, things can get messy.
System Reliability
In an age where businesses are held up by digital stilts, system failures pose a significant threat. Operational risk in systems might include everything from software glitches to catastrophic cyber-attacks. It’s the digital equivalent of ensuring the fort is guarded, not just by having strong walls but also by savvy guards.
External Shockwaves
Finally, operational risk doesn’t turn a blind eye to the external shocks such as natural disasters, geopolitical upheavals, or pandemics (as recent times have starkly reminded us). These are the jokers in the pack that can unsettle any business operation.
Mitigating Operational Risk
Mitigation of operational risk involves a blend of foresight, strategy, and investment in both technology and people. Risk assessments, regular audits, compliance checks, and fostering a risk-aware culture form the pillars of a robust risk management framework.
Related Terms
- Business Risk: The exposure a company has to factors that may lower its profits or lead it to fail.
- Systematic Risk: Market-wide risks that cannot be eliminated through diversification.
- Compliance Risk: Risks of legal or regulatory sanctions, financial loss, or loss to reputation a company might face as a result of its failure to comply with laws, regulations, or codes of conduct.
Suggested Further Reading
- “Against the Gods: The Remarkable Story of Risk” by Peter L. Bernstein
- “Operational Risk Management: Best Practices in the Financial Services Industry” by Ariane Chapelle
Diving into the world of operational risk is akin to becoming the weather forecast expert in business—always prepared for the unexpected downpours.
