Understanding Levels of Operational Risk Management

Operational risk management is a critical aspect of any organization's overall risk strategy.

There are four primary levels of operational risk management:

Preventive, Detective, Corrective, and Preventive-Corrective.

Preventive operational risk management aims to prevent risks from occurring in the first place, often through policies, procedures, and controls.

Detective operational risk management involves identifying and detecting risks that have already occurred, typically through monitoring and reporting.

Corrective operational risk management focuses on mitigating the impact of risks that have already occurred, often through incident response and recovery plans.

Operational risk management is the process of identifying, assessing, and mitigating risks that could impact an organization's operations and profitability. It's a critical component of overall risk management, as it helps prevent losses and ensure business continuity.

Operational risk can arise from a variety of sources, including internal processes, systems, and people, as well as external factors like natural disasters and economic downturns. According to the article, a major bank's operational risk management process involves identifying and assessing risks related to its trading activities, which can have a significant impact on the bank's financial performance.

By implementing effective operational risk management practices, organizations can reduce the likelihood and impact of operational losses, improve their overall risk profile, and enhance their reputation with stakeholders.

The concept of operational risk management has a fascinating history. It all started in the 1970s with the Basel Committee on Banking Supervision, founded in 1974, which aimed to standardize risk management practices in the financial services industry.

Over the years, the discipline of risk management has spread beyond the financial and banking industries. The release of COSO's Internal Control-Integrated Framework in 1992 was a significant milestone, as it provided a framework for organizations to assess their internal controls and risks.

The Sarbanes-Oxley Compliance Act of 2002 put even more pressure on organizations to have an effective operational risk management discipline in place, following high-profile cases of financial fraud at WorldCom and Enron. The audit committee in the U.S. has been a driving force behind this increased involvement of senior executives in risk oversight.

In 2017, COSO released an Enterprise Risk Management Framework, building on their earlier work. Many risk managers have since adopted an operational risk management process, leveraging these frameworks to improve their risk management practices.

Operational risk is an unexpected risk, a form of business risk that occurs when internal processes, humans, or systems fail.

The Basel Committee on Banking Supervision defined operational risk in the early 1990s as the risk of loss resulting from failed internal processes, people, and systems, or external events.

This definition includes legal risk, but excludes strategic and reputational risk.

The definition was crafted purposely for banks to manage financial risks, but it also represents risks found in other industries.

The term operational risk came into existence in the early 1990s, and since then, most companies have been facing such risks when carrying out everyday activities.

The Basel Committee did a great job defining what operational risk is, but they failed to explain what the other group of risks meant, including people risk, process risk, systems risk, and external events risk.

Having a strong operational risk management (ORM) program is crucial for any organization. It helps achieve strategic objectives while ensuring business continuity in the event of disruptions and system failures.

Effective ORM can save an organization in monetary costs by preventing or correcting loss events. It encourages the optimization of business practices to make them more efficient and effective.

Organizations that implement a strong ORM program can experience improved competitive advantages, including better C-suite visibility, informed business risk-taking, improved product performance, and stronger relationships with customers and stakeholders.

Here are some key benefits of a strong ORM framework:

By implementing a strong ORM system, organizations can reduce operational costs, enhance compliance, and improve customer satisfaction.

A strong Operational Risk Management (ORM) program can bring numerous benefits to an organization. It helps achieve strategic objectives and ensures business continuity in the event of disruptions and system failures.

Having a strong ORM program demonstrates to clients that the company is prepared for crisis and loss. This can lead to improved competitive advantages, including better C-suite visibility and informed business risk-taking.

Effective ORM can save an organization in monetary costs by preventing or correcting loss events. It encourages the optimization of business practices to make them more efficient and effective.

A strong ORM framework helps organizations protect their operations and ensure business continuity. This can lead to reduced stress on the organization, as resources are efficiently managed to tackle the outcomes of risks.

Implementing a strong ORM program can also increase customer satisfaction by minimizing factors leading to risk events. This can help a company keep existing customers and avoid the costs of finding new ones.

Here are some of the key benefits of a strong ORM program:

By implementing an effective ORM program, an organization can reduce its operating costs, enhance compliance, and improve its insurance coverage and ratings.

Third-party risk tools help companies assess and select vendors more effectively by measuring their reliance on key third parties, including exposing fourth parties if necessary.

These tools improve vendor assessment and selection, as well as planning of business continuity.

Analytics developments have enabled organizations to rethink their approaches to risk detection, moving beyond subjective controls and self-assessment.

Targeted analytics tools allow organizations to work efficiently, leveraging data-driven insights to inform their risk management strategies.

Resource Shortage is a major obstacle in effective Operational Risk Management (ORM). Many organizations simply don't have the resources to invest in ORM, making it a tenuous link in their ability to meet customer and stakeholder demands.

According to Example 1, lack of resources is a common challenge in ORM, alongside competing priorities and lack of perceived value. This can lead to ineffective ORM programs that are manual, disjointed, and over-complicated.

The issue is further exacerbated by the fact that ORM is often consolidated into other functions, such as compliance and IT, preventing it from receiving the attention it needs. This can lead to a lack of skilled resources, making it difficult to effectively execute ORM.

As Example 5 notes, ORM is plagued by a lack of skilled resources, with little attention and resources provided to the processes that help avert risks to operations. This can make ORM ineffective.

Here are some common reasons why organizations struggle with resource shortages:

These challenges can be overcome by prioritizing ORM, allocating sufficient resources, and providing training and development opportunities for staff. By doing so, organizations can build a strong foundation for effective ORM and mitigate operational risks.

Operational risk management is a crucial aspect of any organization, and it's essential to understand the different levels of operational risk management. The four steps of the ORM process are critical in identifying, assessing, mitigating, and monitoring risks related to an organization's business operations.

Risk identification is the first step in the ORM process, where organizations discover risks associated with different aspects of their operations and their potential impact. This can be done through brainstorming sessions, interviews with stakeholders, and risk assessments.

Organizations use various methods to identify risks, such as risk assessments, and it's essential to understand potential impacts to prioritize risk management efforts.

A Risk Assessment Matrix is a tool used to assign risk assessment codes to each operational risk experienced during the completion of a task.

Risk assessment involves evaluating the exposure, impact, and effects of identified risks, and it's calculated by multiplying the probability of risk occurrence by the potential impact of the risk.

Here are the four steps of the ORM process:

Risk mitigation involves implementing strategies to minimize the likelihood or impact of risks, and it's essential for organizations to have a risk mitigation plan in place to minimize the impact of risks on their operations.

Control implementation involves designing controls specifically to address and mitigate the risk in question, and it's essential to formally document the control rationale, objective, and activity.

Monitoring involves testing the control for appropriateness of design, and operating effectiveness, and any exceptions or issues should be raised to management with action plans established.

By following these four steps, organizations can effectively manage operational risks and ensure the smooth operation of their business.

Assessment and Mitigation is a critical part of operational risk management. It involves evaluating risks and determining the best course of action to mitigate them.

To assess risks, you need to use an impact and likelihood scale, also known as a Risk Assessment Matrix. This helps categorize risks by type and level, making it easier to prioritize and rank them.

Risk mitigation involves developing strategies to minimize the likelihood or impact of risks. This can include implementing controls, transferring risks to third parties, or accepting risks. Organizations should have a risk mitigation plan in place to minimize the impact of risks on their operations.

There are four options for addressing potential risk events: transfer, avoid, accept, and mitigate. Transfer involves shifting the risk to another organization, while avoid means preventing the organization from entering into a risk-rich situation. Accepting a risk means comparing the risk to the cost of control and deciding to move forward with the risky choice.

Here are the four options for addressing potential risk events:

By understanding the different options for addressing potential risk events, organizations can make informed decisions and develop effective risk mitigation strategies.

The inability to detect new risks is a significant challenge to operational risk management (ORM). Failure to detect new risks creates gaps in risk management strategies and existing risks.

New risks can arise in the operational environment due to an ever-evolving market and dynamic economy. This makes it difficult for organizations to keep up with the changing risk landscape.

As a result, organizations may struggle to mitigate all risks to their operations, which can have serious consequences.

Data Inconsistency can make it difficult to accurately assess operational risks. This is because operational risks often involve multiple data sources and systems, leading to inconsistencies.

Data may be outdated or inaccurate due to the dynamic nature of operational risks. These risks are constantly evolving, making it challenging to keep data up to date.

Inconsistent data can lead to poor decision-making, as organizations may rely on incomplete or inaccurate information. This can ultimately hinder their ability to effectively manage operational risks.

Measurement and Mitigation is a crucial step in the risk assessment process. It involves evaluating the exposure, impact, and effects of identified risks, which can be calculated by multiplying the probability of risk occurrence by the potential impact of the risk.

A risk assessment matrix is a useful tool for categorizing and prioritizing risks. It assigns risk assessment codes to each operational risk experienced during the completion of a task. The risk assessment matrix is a simple yet effective way to visualize the level of risk associated with each potential risk event.

Risk scoring is another method used to quantify risk. It involves using statistical analysis to understand the level of associated risk. Common methods of risk scoring include range analysis, probability analysis, and impact analysis. For example, if a company targets working only with highly creditworthy vendors, it may set a key risk indicator (KRI) that no more than three vendors default on a contract.

In the Operational Risk Management process, there are four options for addressing potential risk events: transfer, avoid, accept, and mitigate. Transferring involves shifting the risk to another organization, such as outsourcing or insuring. Avoidance prevents the organization from entering into a risk-rich situation or environment. Acceptance involves comparing the risk to the cost of control and deciding whether to move forward with the risky choice. Mitigation involves implementing action plans and controls that reduce the likelihood of the risk and/or the impact it would have if the risk were realized.

Here is a summary of the four options:

Risk mitigation involves implementing strategies to minimize the likelihood or impact of risks. This may include implementing controls, transferring risks to third parties, or accepting risks. It is essential for organizations to have a risk mitigation plan in place to minimize the impact of risks on their operations.

Key risk indicators (KRIs) are metrics a company may self-assign as risk benchmarks. They can help managers monitor risk levels, signal changes in exposure, assess the effectiveness of controls, and ensure that the organization operates within its set risk appetite. KRIs are most often quantifiable, making it easier to track and measure their effectiveness.

Monitoring and reporting are crucial components of operational risk management. Risks are monitored through an ongoing risk assessment to determine any changes over time.

The goal of monitoring is to identify potential issues before they become major problems. Control monitoring involves testing the control for appropriateness of design, and operating effectiveness.

Any exceptions or issues that arise during monitoring should be raised to management with action plans established. This helps organizations understand the status of their risk management efforts and take appropriate actions to address risks.

Risk reporting involves communicating risk information to relevant stakeholders, which may include preparing risk reports, presenting risk information to management or the board of directors, and disclosing risk information to regulators or investors.

Monitoring and reviewing operational risks is a crucial step in the risk management process. This involves regularly checking to see if the controls put in place are still effective.

Risks are monitored through an ongoing risk assessment to determine any changes over time. This helps identify potential issues before they become major problems.

Continuous monitoring or early warning systems can be used to catch potential risks early on. Key risk indicators (KRIs) can be designed to monitor specific areas of the business, such as customer satisfaction scores. Falling customer satisfaction scores could indicate a need for improved training or customer service processes.

Monitoring involves testing controls for appropriateness of design and operating effectiveness. Any exceptions or issues should be raised to management with action plans established.

The final step in the ORM process is monitoring and reviewing the situation. This includes ensuring all controls are effective and in place, and taking action on ineffective risk controls.

Reporting is a crucial part of monitoring and managing risks. It involves communicating risk information to relevant stakeholders.

Risk reporting may include preparing risk reports. These reports help organizations understand the status of their risk management efforts.

Presenting risk information to management or the board of directors is also part of risk reporting. This ensures that decision-makers have the information they need to make informed choices.

Risk reporting may also involve disclosing risk information to regulators or investors. This is often required by law or industry standards.

Risk reporting helps organizations take appropriate actions to address risks. By understanding the status of their risk management efforts, organizations can make informed decisions and take proactive steps to mitigate risks.

Technology plays a significant role in operational risk management, encompassing hardware, software, privacy, and security risks.

Hardware limitations can hinder productivity, especially in remote work environments, where employees may struggle to perform tasks efficiently due to outdated or inadequate equipment.

Software outages can also impact productivity, causing employees to spend valuable time resolving issues rather than focusing on their work.

External threats, such as hackers attempting to steal information or hijack networks, can lead to leaked customer information and data privacy concerns.

Business continuity plans should address risks related to technology failures and other disruptions to minimize the impact on the organization.

Systems risk is a significant concern, as it involves the potential for damage, unauthorized access, or deletion of critical business data.

The following are some key aspects of systems risk:

Operational risk management software solutions, such as those mentioned in Chapter 9, can help identify and test operational risks across an organization's departments.

Advanced analytics tools, like those discussed in Chapter 8, can aid in detecting operational risks by reducing false positives and revealing risks faster.

Regulations and compliance are a crucial aspect of operational risk management. The number and complexity of rules have increased over the past decade, and penalties have become more severe.

Understanding the sources of risk will help determine who manages operational risk. This is where Integrated Risk Management or IRM comes in, addressing risk from a cultural point of view.

Regulatory compliance is essential for doing business, and an Operational Risk Management tool can help guarantee it. By ensuring regulatory compliance, you can improve your competitive edge and reduce operational costs.

Incorporating systematic quality control tools can help check the accuracy of filings, disclosures, and decision-making processes against regulatory rules. This ensures adherence to disclosure rules and helps minimize business disruption.

Legal and compliance risks are risks associated with regulatory authorities, jurisdictions, and geopolitics of a particular market.

These risks differ depending on the operating region and affect the organization differently in different areas. The risks typically involve the risk of changing regulations, policies, and new tax regimes.

Regulatory compliance is part of doing business, and it's essential to ensure it's met to improve your competitive edge.

You can identify and prioritize operational risks, assess their impact on the business, and develop controls to mitigate them by integrating operational risk management with Governance, Risk, and Compliance (GRC).

By integrating ORM with GRC, organizations can ensure that risk management is aligned with the organization's overall strategy, and that compliance requirements are met while minimizing business disruption.

Traditional rules-driven alerts are often used by organizations to manage money laundering risks, but they can lead to false positives and wasted resources.

Adopting machine-learning analytics tools is a better approach to risk assessment and management, as they can reduce false positives.

These tools can channel resources towards cases that need immediate investigation, making them a more efficient use of time and money.

Machine-learning analytics tools are necessary for better risk assessment and management, and they can provide a more accurate picture of money laundering risks.

An effective Operational Risk Management Framework (ORMF) can be developed through a process that involves governance structure, operational risk identification, assessment, measurement methodologies, policies, procedures, and processes for mitigating, controlling, monitoring, and reporting of operational risks.

Building a robust ORMF requires a structured approach that helps businesses proactively identify, assess, prioritize, monitor, and report operational risks, such as process failures or human error, to minimize potential losses and exploit opportunities.

A strong ORM framework helps organizations protect their operations and ensure business continuity by identifying and mitigating operational risks.

An ORM framework can be developed through a process that involves governance structure, operational risk identification, assessment, measurement methodologies, policies, procedures, and processes for mitigating, controlling, monitoring, and reporting of operational risks.

By implementing an effective ORM framework, organizations can minimize potential losses and exploit opportunities, ultimately leading to business success.

Dataminr is an ORM program that uses AI to detect high-impact events and emerging risks in real-time, giving organizations critical insights into events happening around their area of operations.

Dataminr is best for businesses, public organizations, and newsrooms that need to respond quickly to emerging risks.

LogicManager helps bridge silos in risk management by interconnecting operational risks, preparing organizations for future threats with quality risk data.

LogicManager features a centralized risk management hub, unlimited risk management support, and expert risk management consultants to guide businesses.

Archer brings consistency to risk management by standardizing processes and establishing a common risk language, measurement approach, and reporting system.

Archer helps organizations create a culture of accountability by getting the right information to the right people to reduce risk and drive accountability.

LogicGate Risk Cloud is designed to help organizations accurately identify, assess, and monitor business risks with agility, and it's suitable for various industries, including energy, financial services, healthcare, and technology.

MetricStream's Operational Risk Management software helps organizations follow a robust risk management discipline and adopt a pervasive approach to operational risk management, improving risk visibility and foresight with predictive risk metrics and indicators.

Here are some key features of ORM software:

Dataminr is an ORM program that uses AI to detect the most relevant, high-impact events and emerging risks in real-time. It's designed to help organizations respond with speed and confidence.

Dataminr gives global enterprises, public organizations, and leading newsrooms critical insights into events happening around their area of operations. This helps them identify assets that require extra protection before they can be damaged.

Dataminr is particularly useful for businesses, enabling them to identify and respond to emerging risks in a timely manner. It's also a valuable tool for the public sector, allowing for the fastest real-time response to events.

Dataminr helps newsrooms discover stories that matter early, giving them a competitive edge in the industry. This ORM program alerts users ahead of anyone else to potential risks in all areas of interest.

Dataminr is best suited for:

LogicGate Cloud is an effective ORM software that helps you accurately identify, assess, and monitor business risks with great agility. It's designed to power agile risk management across various industries, including energy, financial services, healthcare, and technology.

This software is great for identifying and assessing operational risks, and it can even identify information risk with pinpoint accuracy. It also swiftly resolves any exposure, giving you peace of mind.

LogicGate Cloud also excels at third-party risk management by automating third-party risk assessments and risk scoring. This improves security and privacy, and it's a game-changer for organizations that work with third-party vendors.

Here are some key features of LogicGate Cloud:

Overall, LogicGate Cloud is a top-notch ORM software that can help your organization stay on top of risks and ensure compliance.