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Operational Risk Management

There are many types of business risks out there, and thus there are many different types of risk management.
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Operational Risk Management

Have you heard of operational risk management? Operational risk refers to a loss that occurs as a result of failed or inadequate operations within a business. Operational Risk Management (ORM) refers to the process of identifying, assessing, measuring, mitigating, monitoring, and reporting risks to reduce and handle them. 

In this guide, we’ll break down how operational risk management works in more detail, along with some examples, challenges, and benefits of using ORM.

What is Operational Risk? 

Operational risk is a term that describes the risks and uncertainties that a corporation encounters when doing day-to-day business activities in a certain area or industry. It's a sort of business risk that arises from flaws in internal procedures, people, and systems, as opposed to issues caused by external influences like political or economic events, or difficulties that are intrinsic to the whole market or market sector, which is known as systemic risk.

Operational risk is concerned with how things are done within a company rather than what is produced or inherent in the industry. These dangers are frequently linked to deliberate decisions about how the organization operates and what it emphasizes. While failure, poorer output, or greater total costs are not inevitable, the risks are viewed as larger or lower based on numerous internal management decisions.

Examples of Operational Risk 

Maintenance of required systems and equipment is one area where operational risk may exist. If two maintenance operations are necessary but only one can be performed at the moment, the operational risk changes depending on which system is left in disrepair. The negative impact of a system failure is directly related to the operational risk.

Other aspects that fall under the category of operational risk usually include the human element inside the company. This conduct is considered an operational risk if a sales-oriented company decides to keep a mediocre sales crew owing to lower wage expenses or any other reason. The same may be failing to keep staff in good working order in order to prevent certain hazards. Choosing not to have a competent mechanic on staff and having to rely on third parties for such work, for example, might be classed as an operational risk in a manufacturing business. Not only does this influence a system's seamless operation, but it also adds to the amount of time it takes.

What is Operational Risk Management? 

ORM (operational risk management) is a recurrent process that comprises risk assessment, risk decision making, and risk control implementation, resulting in risk acceptance, mitigation, or avoidance.

Every business encounters conditions or fundamental changes in its status that might pose varying levels of risk, ranging from small inconveniences to a situation that could put the company's whole operation in danger.

When dealing with operational risk, the company must take into account all of its goals. Due to the pervasiveness of operational risk, the objective is to minimize and control all risks to a tolerable level. Operational Risk Management aims to decrease risks by identifying them, assessing them, measuring and mitigating them, and monitoring and reporting them.

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The 4 Principles of ORM

Depending on your company's needs and circumstances, your risk profile will be unique. The majority of programs, on the other hand, are based on the following principles:

  1. Take risks only when the possible advantages outweigh the potential drawbacks.
  2. Don't take any risks that aren't absolutely essential.
  3. Prepare ahead of time to anticipate and limit danger.
  4. Address risks at the right level.

The term "level of risk" refers to a method of determining which risks are the most critical and, as a result, must be addressed within a specific time frame. In an ideal world, a company's resources would allow it to analyze and treat all risks equally, but in reality, you'll have to make judgments depending on which threats have the most potential for harm. The following are the risk levels:

  • These hazards, also known as “in-depth”, are not time-sensitive and may be analyzed over a longer period of time. This level is ideal for fresh threats that need additional research to properly comprehend.
  • The majority of hazards fall into this "mid-level" group. It is detailed and deliberate, but it is intended for risks that do not need the same level of investigation as a strategic level risk.
  • This category is allocated for imminent dangers, as the name implies. This category is for a danger that necessitates a swift decision in a short amount of time.

Understanding these concepts can assist you in adjusting a broad ORM framework to one that is tailored to your company's particular requirements.

The Steps in Operational Risk Management

The basic goal of operational risk management is to prevent risk (or, if that isn't possible, to minimize loss). Follow these basic steps to understand which dangers affect you and what you can do to avoid them:

  1. Identify the risk.
  2. Assess the risk.
  3. Mitigate the risk.
  4. Monitor the potential for new risks.

Risk mitigation is likely the most crucial phase since it is here that you will choose how to handle the hazards identified during your risk assessment.

What are the Challenges and/or Benefits of Implementing an ORM Strategy?

Operational risk management's key advantages include assisting a corporation in accomplishing the following:

  • Detect illegal activity much earlier. 
  • Lower the cost of compliance.
  • Reduce the possibility of future dangers causing harm.
  • Improve the resiliency of the company's operations.
  • Enhance the efficiency of its risk management activities.
  • Strengthen the decision-making process, when there are dangers involved.
  • Reduce the amount of money you lose as a result of hazards that aren't properly addressed.

Setting up an efficient operational risk management program may help a firm accomplish its strategic goals while also assuring business continuity in the event of a disruption.

ORM is not without its challenges, though. Improving risk data quality is one challenge. Data quality has long been a source of operational risk, with data being exchanged via spreadsheet platforms or in-point solutions with no real regard for data lineage or accuracy checks. The poor quality of risk and control data startled many boards and top management under pressure to respond fast to the COVID-19 pandemic. Operational risk management teams must embrace the growing need for data governance more than ever before.

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