Operational risk refers to the risk which results when a company fails to operate correctly. It can be caused by failed policies, procedures or systems of the enterprise. It is an accepted fact by most of the companies that operational risk is sometimes inevitable. It can result from employees’ mistakes as well as failed policies.
This type of risk is not associated with other types of financial risks. It remains even after determining the financial risk associated with a procedure. It usually results from the breakdown of internal processes, people, and systems of the company.
Sometimes the company owners make poor choices that affect the business negatively. Sometimes the company’s employees are not efficient or sincere enough to bring the company a good result. Operational risk can also be named as a human risk because it is caused by human errors.
It changes from company to company. A group having the less human interaction is less likely to suffer from this loss since there won’t be many humans to make mistakes. It can also include other forms of risk such as fraud, security, legal risks, environmental hazards, etc.
Causes of Operational Risk:
Operational risk depends upon the overall culture of an organization, how things are done and goals are accomplished there. A productive approach to achieve the company’s goals reduces the risk.
Also, the decision was taken by the authoritative figures of the group affect the level of operational risk involved. Right choices are the key to success. While there is this danger, but it does not guarantee the failure of the company.
If a system fails to work in a company, it might result in a loss for the enterprise. If there are two systems at a time in the industry that needs attention, and the company has enough funds to only support repairing of one of them, then the system that is left unattended results into causing loss. Other risk factors may involve insufficiency of employees.
For example, if a company hires subpar employees due to the lower amount of salary that the firm would have to offer to them, it is considered an operational loss. The same happens when the company fails to train their staff as per its needs.
Similarly, in a manufacturing related company, a mechanic should be available at all times. Failure to arrange one causes operational risk. It not only halts the company’s processes but also wastes time.
The operational risk can be caused by following events:
- Internal fraud: tax evasion, bribery, etc
- External fraud: theft of information of the company, hacking
- Employment practices: discrimination among the workers
- Workplace safety: not providing a safe and peaceful working environment
- Damage to material possessions: natural disasters or terrorism may destroy company’s assets resulting from loss
- System failures: failures in the proper functioning of hardware and software of the company
- Data entry errors: human errors such as accounting errors etc
Operational Risk Management:
Operational risk can be lessened by using some methods. The methods designed to manage the operational risk should include identification of the operational risk, measurement, and monitoring of the operational risk, controlling and mitigation of the operational risk. Main approaches:
- Basic indicator approach
- Standardized approach
- Advanced measurement approaches
It is essential to address all the factors that increase operational risks such as employees’ error, failure of the systems of the company, fraud or other criminal activities carried out against the interest of the enterprise, any other event in the business that disrupts the usual practices. If it has to be mitigated, the reasons should be appropriately understood so appropriate action can be taken.