Ever consider the chances your company faces simply in the course of conducting its daily business activities, procedures, and systems? Many don’t, neglecting operational risk management in the process, just as the overall operational risk picture darkens.
How to manage operational risk effectively? This article defines what operational risk is before laying out the key strategies needed to manage operational risk.
What is operational risk?
So, what are operational risks?
Put simply, operational risks are the risks of doing business; these are the risks businesses face from ineffective or failed internal processes, people, systems, or external events.
Operational risks, as defined, can come from anywhere, including technology, employees, or regulators.
What they have in common, though, is that if realized, operational risks can lead to serious losses – not just financial losses, but non-direct costs, as well.
Indeed, poorly managed, operational risks can have the following impacts on your business:
- Enterprise-wide interruption, disruption, or failure
- Loss of systems control or data
- Financial loss
- Safety hazards
- Reputational damage
- IT infrastructure damage
- Customer churn
- Employee churn
- Legal liability or regulatory fines for harm caused by employees intentionally or negligently
- Legal liability or regulatory fines for harm caused by external bad actors
- Competitive disadvantage
The benefits of operational risk management
As a result, operational risk management serves the purpose of minimizing the threat of operational risks. Operational risk management also offers the following benefits:
Operational risk management creates and protects value
Risk management contributes to the achievement of objectives and improvement of performance in, for example, human health and safety, security, legal and regulatory compliance, public acceptance, environmental protection, product quality, project management, efficiency in operations, governance and reputation.
Operational risk management is an integral part of all organizational processes
Risk management is not a stand-alone activity that is separate from the main activities and processes of the organization. Risk management is part of the responsibilities of management and an integral part of all organizational processes, including strategic planning and all project and change management processes.
Operational risk management enhances decision making
Risk management helps decision makers make informed choices, prioritize actions, and distinguish among alternative courses of action.
Operational risk management helps to better address uncertainty
Risk management takes account of uncertainty, the nature of that uncertainty, and how it can be addressed.
Operational risk management makes companies better responsive to change
Risk management continually senses and responds to change. As external and internal events occur, context and knowledge change, monitoring and review of risks take place, new risks emerge, some change, and others disappear.
Operational risk management facilitates continual improvement
Organizations should develop and implement strategies to improve their risk management maturity alongside all other aspects of their organization.
Challenges to operational risk management
The benefits don’t discount the clear challenges, though.
Operational risk management can be difficult even in the best of times – and we’re not in the best of times.
Add to that, the cost of effective operational risk management isn’t trivial.
What are the other challenges to successful operational risk management? They include:
Limited resources for controlling identified risk
Companies might uncover numerous operational risks as part of the risk management process. However, it takes resources (outlays of personnel, technologies, and/or other assets) to tackle those risks. Company resources are finite.
Sheer pace and volume of change overwhelming risk teams
The rationale for getting started with operational risk management today is that the risk picture is deteriorating quickly. Indeed, this change in the threat environment is overwhelming many companies who are facing multi-directional risk.
Lack of a comprehensive, integrated operational risk management approach
Companies often pursue operational risk on an ad hoc basis. This might be fine if a company only faces one risk at a time. But as risk accumulates – itself a sign of business maturation – this approach will become untenable.
Lack of internal (communications) tools to properly integrate the knowledge base of risk into systems for managing risk
Companies also find themselves stymied once they’ve identified risks. What to do then? Without internal tools to properly integrate the knowledge base of risk into risk management systems, risks will remain un-controlled.
Six strategies to manage operational risk
So, how to go about achieving operational risk management?
Operational risk management is an actual process (or cycle) of risk assessment, decision making, and implementation (of controls) that needs to be pursued.
The precise strategies needed to implement effective operational risk management include the following:
1. Risk identification
The identification stage consists of isolating all potential operational risks, whether recurring risks or potential one-offs. Risk identification involves staff across the business, not just C-suite executives.
2. Risk assessment
Once identified, operational risks must be added to a risk register where they are to be assessed based on a number of factors, like how likely the risk is to occur, how frequently the risk will occur, and the potential risk exposure to human and non-human assets if the risk is not managed.
The use of a risk matrix, an established risk assessment methodology, is a standardized way of prioritizing risks in a central risk register by likelihood and consequences.
The severity of each risk can then be assessed separately, either as inherent, target, or residual risk, using a common methodology. At the end of the evaluation, risk is traditionally categorized as either very high, high, medium, low, or very low.
3. Analysis
In analyzing risk, teams will consider which risk controls (if any) to put in place. Additionally, teams will provide decision makers with a thorough risk analysis, a clear cost and benefit evaluation as well as outlines of possible alternative measures to take.
4. Decision
Based on the analysis furnished, decision makers will choose the best control (or combination of controls).
5. Implementation
Carrying out the decision taken requires having a plan for applying the selected controls. Adequate time and resources must also be allocated for any control measure to be successful. In addition, implementing controls requires clearly communicating your plan to everyone involved.
6. Monitoring
Implementation, however, isn’t the end of the story. Once they’re put in place, controls will have to be consistently monitored to ensure they are working as expected.
Examples of operational risk management
So, what are examples of operational risk management strategies than can be implemented and monitored? Generic risk management strategies tend to include risk avoidance, risk acceptance, risk transfer, risk reduction, and risk retention.
They mean:
Risk avoidance
The elimination of hazards, activities, and exposures that can negatively affect an organization and its assets.
Risk acceptance
The acknowledging of the possibility for small or infrequent risks without taking steps to hedge.
Risk transfer
The process of formally or informally shifting the financial consequences of particular risks from one party to another.
Risk reduction
The mitigation of impact of potential losses by reducing the likelihood and severity of a possible loss.
Risk retention
The planned acceptance of potential losses.
Implementing operational risk management at your enterprise
So, what can be done, especially if you can’t adequately control all your company’s identified risks? Well, the most sensible way to properly implement risk management in any organization is to pursue informed risk profiling and decision making toward increased returns.
After all, risk is inevitable. Tradeoffs in operational risk management are unescapable. To make better-informed tradeoffs, stakeholders need to operate with a strategic, business perspective in mind, anchoring their risk management practices within a larger, organizational context.
Turning these guidelines into practices will start at the top, with executives promoting greater risk awareness and transparency. Executives must also empower staff to contribute their own ideas to improve risk processes and controls.
What’s more, a robust reporting culture will also facilitate a supportive risk culture. How to get better reporting outcomes?
Executives will have to invest in the appropriate tools to enable their teams to fully assess and document risks, including detailed information on why certain identified risks were accepted (and others not).
Additional ways to implement operational risk management in the enterprise include:
- Limit risk decision making to leaders who have the power to allocate resources
- Have clear organizational objectives
- Identify risk roles and responsibilities
- Put a support structure in place
- Deploy early warning systems
- Ensure risk decisions go through a clear review cycle
Manage your operational risk with Noggin
Seem overwhelming? It doesn’t have to. Digital operational risk management software helps companies mitigate operational risks and strengthen enterprise resilience.
Solutions like Noggin Resilience, in particular, help organizations proactively identify, assess, and mitigate potential risks that could cause operational failures or disruptions to their normal operations. Our integrated resilience workspace provides a holistic view of risks, streamlines operational risk-related processes, and fosters effective stakeholder collaboration and communication.
But don’t just take our word for it. Check out Noggin for yourself in a tailored demonstration.
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