Different Types of Risk. Operational Risk. Strategic Business Risk. Reputational Risk.
Friday, July 10th, 2009What Is Operational Risk?
Operational risk is different from all other risks. It is typically defined by a variety of international sources, including government agencies, quasi-governmental bodies, professional organizations, and consulting firms, as the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events. There is no expected reward or return on investment, like one would expect from taking market or credit risk. The only “reward” from successfully managing or mitigating an operational risk is the reduction of a potential loss.
The key difference between operational risk and all other types of risks is expectation. We expect market risk when we purchase an investment. We expect credit risk when we loan money to someone else. We do not expect a process or system to not work. We expect things to work. We do not expect things to go wrong. Operational risk is the risk of loss from something’s unexpectedly going wrong. We do not want operational risk, although we are forced to live with it.
Operational risk = The risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events.
Operational risk includes legal risk, but excludes other risks that are not part of market or credit risk categories, such as strategic business risk and reputational risk. Strategic business risk is the risk of a loss from a poor strategic business decision, such as opening a store in the wrong location or producing a product no one would purchase. Reputational risk is the risk of a loss due to a change in a company’s reputation or standing in the market or community. Yet, a significant operational risk loss or failure would definitely adversely impact the reputation of a company. Therefore, strategic/business, credit, market, liquidity, and operational risk all affect a company’s reputation and by their nature create, increase, reduce, or alleviate reputational risk.
Operational risk is typically associated with the following types of potential loss:
? People. Employees could intentionally or unintentionally make mistakes or fail to follow existing policies or procedures, resulting in losses.
? Process. Deficiencies in an existing procedure, or the absence of a procedure could result in losses.
? Systems. Automated processes and systems plus the underlying technology security or infrastructure could break down and cause losses.
? External. Third-party actions and other artificial or natural forces could create losses for a company.
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