| In much the same light as the management of | | | | “Systems” – Most procedures require |
| market risk and credit risk is vital to preserve a | | | | the use of outside apparatus. These could be |
| business. Many banks and firms see operational risk | | | | computer systems or machinery or tools. Getting |
| and its management only as a response to the | | | | back to our waking up “process” something |
| requirements of regulators. | | | | like our toothbrush can be seen as such a system. |
| They see operational risk from a totally different | | | | “External events” – Our processes take |
| viewpoint to the management of market risk and | | | | place in the wider world. This environment is |
| credit risk. The latter two are accepted as being vital | | | | constantly under threat of disruption. Disruptions |
| to ensure the survival of the business, while | | | | could be bad weather, natural disasters, pandemics, |
| operational risk is seen as something else entirely. For | | | | political turmoil, social unrest and so on. |
| many businesses the management of operational risk | | | | Within this context there are eight key issues that |
| is perceived as a nuisance with added costs and | | | | need to be addressed if management of Operational |
| other inconveniences imposed by some outside | | | | Risk is to be effective. |
| bureaucrat. | | | | 1. Internal Environment. The internal environment |
| Of course this perception is totally wrong. | | | | relates to how the firm sets the tone and what is |
| In this article we are going to examine the 8 key | | | | called its “risk appetite”. This relates to the |
| issues that one needs to keep in mind when | | | | firms’ policy in relation to risk and the extent to |
| managing operational risk. Let us begin with a | | | | which the firm is prepared to accept risk. Remember |
| definition of operational risk. | | | | that risk cannot be eliminated entirely but it can be |
| “Operational risk is the risk of loss resulting from | | | | mitigated. |
| inadequate internal processes, people, and systems | | | | 2. Setting Objectives. Based on the firm’s define |
| or from external events”. | | | | risk appetite explicit objectives can now be set in |
| Operational risk can be equated in a broad sense with | | | | terms of “risk events” and their |
| unexpected risk, meaning that while we may have a | | | | management. |
| pretty good feel for risks such as credit risk or | | | | 3. Event Identification. This is a definitive list of what |
| market risk which can often be anticipated with a fair | | | | risks the firm faces and how they can be identified. |
| amount of accuracy, when we get to the operational | | | | 4. Risk Assessment. It is vital that in reviewing the |
| side this usually is pretty much an unknown quantity. | | | | risks these have to be understood in terms of the |
| | | | | dangers that they present to the firm. This |
| Let’s look a little more closely at the elements of | | | | assessment requires an analysis of and an |
| this definition. What do we understand by some of | | | | understanding of what these risks are. |
| its components? | | | | 5. Risk response. What is the firm going to do about |
| "People” - People are employees; our workers. | | | | the risk? What actions is it going to take to reduce |
| Employees can make mistakes. These could be | | | | and mitigate these risks or to compensate for the |
| intentional or unintentional. People also often fail to | | | | potential loss? |
| follow correct procedures which can result in losses. | | | | 6. Control Activities. This is part of the risk |
| “Processes” – All business activities are | | | | management process that in advance develops plans |
| made up of processes. These may be complex | | | | to respond to these previously identified risks. |
| sequences of events such as one finds in a factory | | | | 7. Information and communication. A vital part of |
| engaged in manufacture or a more simple sequence | | | | managing risk is effective communication and |
| of tasks involved in taking an order and dispatching | | | | information to people both inside and outside the |
| the goods to a purchaser. All activities involve | | | | organization in relation to the roles and the |
| procedures. Just think of all the detail involved in the | | | | responsibilities they have in responses to the various |
| procedure that we all follow each and every day | | | | risks. |
| when we wake up and get ready to leave home to | | | | 8. Monitoring. This is the ongoing process of reviewing |
| go to work. | | | | and evaluating the business processes and the |
| If there are deficiencies in an existing procedure, or if | | | | effectiveness of the risk management programme. |
| no procedure is defined, this could result in losses. | | | | |