Operational risk management (ORM) is a continual recurring process that includes risk assessment, risk decision making, and the implementation of risk controls, resulting in the acceptance, mitigation, or avoidance of risk.
Every organization faces circumstances or fundamental changes in its situation that can present varying levels of risk to that business, from minor inconveniences to a situation that could put the entire company at risk.
Examples of operational risk include:
- Employee conduct and employee error
- Breach of private data due to cybersecurity attacks
- Technology risks tied to automation, robotics, and artificial intelligence
- Business processes and controls
- Physical events that can disrupt a business, such as natural disasters
- Internal and external fraud
The Basel Committee on Banking Supervision has described the operational risk as: “the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events. As such, operational risk captures business continuity plans, environmental risk, crisis management, process systems, and operations risk, people-related risks and health and safety, and information technology risks.”
Operational risk management is often discussed in the context of financial services.
An operational risk management process is necessary for organizations that want to avoid potentially disastrous issues.
Benefits of ORM
The main benefits of operational risk management include helping a company to:
- Improve the reliability of its business operations
- Improve the effectiveness of its risk management operations
- Strengthen the decision-making process where risks are involved
- Reduce losses caused by poorly-identified risks
- Identify unlawful activities early
- Lower compliance costs
- Reduce the potential damage from future risks
Establishing an effective operational risk management program helps a company achieve its strategic objectives while ensuring business continuity in the event of disruptions to operations.
Having a strong organization risk management program also lets customers know that the company is prepared to deal with disasters and loss. Organizations that can effectively implement a robust organizational risk management program can experience improved competitive advantages, including:
- Better C-suite visibility
- Better informed business risk-taking
- Improved product performance and better brand recognition
- Stronger relationships with customers and stakeholders
- Greater investor confidence
- Better performance reporting
- More sustainable financial forecasting
Stages of Operational Risk Management
The stages of operational risk management:
- Identifying risk
- Risk assessment
- Measurement and mitigation
- Monitoring and reporting
The first stage of an operational risk management strategy is understanding the nature of the business and the potential risks associated with that company. If possible, identifying risk must involve employees from all levels of the business.
After the organization identifies the risks, it has to assess them. Companies have to do this from a quantitative and qualitative perspective and consider such factors as the frequency and severity of occurrence. The assessment has to prioritize the management of these risks corresponding to these factors.
Measurement and mitigation
Mitigating these risks, or totally eliminating them, is the next stage. Organizations need to put controls in place to limit their exposure to the risks and the potential damage caused by these risks. Metrics like key risk indicators (KRIs) can help managers prevent losses.
Monitoring and reporting
Any operational risk management plan must have a process in place for the ongoing monitoring and reporting of these risks, in part to demonstrate how effective the plan has been. This process should ensure that the solutions put in place are continuing to be effective and are still managing the risks.
Establishing effective risk management capabilities is key to enabling better business decision making and an important tool that the C-suite can use to gain a competitive advantage.