Which statement best describes operational risk management?
What Is Operational Risk?Operational risk summarizes the uncertainties and hazards a company faces when it attempts to do its day-to-day business activities within a given field or industry. A type of business risk, it can result from breakdowns in internal procedures, people and systems—as opposed to problems incurred from external forces, such as political or economic events, or inherent to the entire market or market segment, known as systematic risk. Show
Operational risk can also be classified as a variety of unsystematic risk, which is unique to a specific company or industry. What Is Operational Risk?Understanding Operational RiskOperational risk focuses on how things are accomplished within an organization and not necessarily what is produced or inherent within an industry. These risks are often associated with active decisions relating to how the organization functions and what it prioritizes. While the risks are not guaranteed to result in failure, lower production, or higher overall costs, they are seen as higher or lower depending on various internal management decisions. Because it reflects man-made procedures and thinking processes, operational risk can be summarized as a human risk; it is the risk of business operations failing due to human error. It changes from industry to industry and is an important consideration to make when looking at potential investment decisions. Industries with lower human interaction are likely to have lower operational risk. Operational risk falls into the category of business risk; other types of business risk include strategic risk (not operating according to a model or plan) and compliance risk (not operating in accordance with laws and industry regulations). Examples of Operational RiskOne area that may involve operational risk is the maintenance of necessary systems and equipment. If two maintenance activities are required, but it is determined that only one can be afforded at the time, making the choice to perform one over the other alters the operational risk depending on which system is left in disrepair. If a system fails, the negative impact is associated directly with the operational risk. Other areas that qualify as operational risk tend to involve the personal element within the organization. If a sales-oriented business chooses to maintain a subpar sales staff, due to its lower salary costs or any other factor, this behavior is considered an operational risk. The same can be said for failing to properly maintain a staff to avoid certain risks. In a manufacturing company, for example, choosing not to have a qualified mechanic on staff, and having to rely on third parties for that work, can be classified as an operational risk. Not only does this impact the smooth functioning of a system, but it also involves additional time delays. The willing participation of employees in fraudulent activity may also be seen as operational risk. In this case, the risk involves the possibility of repercussions if the activity is uncovered. Since individuals make an active decision to commit fraud, it is considered a risk relating to how the business operates. key takeaways
Operational Risk vs. Financial RiskIn a corporate context, financial risk refers to the possibility that a company's cash flow will prove inadequate to meet its obligations—that is, its loan repayments and other debts. Although this inability could relate to or result from decisions made by management (especially company finance professionals), as well as the performance of the company products, financial risk is considered distinct from operational risk. It is most often related to the company's use of financial leverage and debt financing, rather than the day-to-day efforts of making the company a profitable enterprise. What is operational risk?Operational risk is the risk of losses caused by flawed or failed processes, policies, systems or events that disrupt business operations. Employee errors, criminal activity such as fraud, and physical events are among the factors that can trigger operational risk. Most organizations accept that their people and processes will inherently incur errors and contribute to ineffective operations. In evaluating operational risk, practical remedial steps should be emphasized to eliminate exposures and ensure successful responses. If left unaddressed, the incurrence of operational risk can cause monetary loss, competitive disadvantage, employee- or customer-related problems, and business failure. What are the causes of operational risk?The causes of operational risk can stem from people inside or outside the organization, technology, processes or even external events, including the following:
People and decisions made by people (human error) tend to cause most operational risks. What are examples of operational risks?The above-mentioned causes of operational risks may result in one of more of the following outcomes:
See also Basel II event categories below. How is operational risk measured?Two things are generally required to measure operational risk: key risk indicators (KRIs) and data. Measurement, however, can be especially challenging when organizations are unable to integrate all the diverse types of data required to understand the organization's operational risk. This might be due to the absence of software that enables the collection of data from different systems and the analysis of that data or to data silos erected by organizational fiefdoms, among other factors. As organizations become increasingly digital, thereby utilizing more data, operational risk managers should continually monitor and assess risks in real time to minimize their potential impact. What key risk indicators should businesses track? That depends on the industry in which they operate. For example, banks follow guidance from the Basel Committee on Banking Supervision (BCBS), which lays out approaches for measuring operational risk and requires banks to allocate a certain amount of capital to cover losses from operational risk. Some of the ways companies can measure operational risk, not all of which are ideal, are the following:
Basel II event categoriesBasel II, a set of international banking regulations initially published in 2004, is the second of three Basel Accords created by BCBS -- Basel III, developed in direct response to the financial crisis, goes into effect in January 2023. Here are the seven categories of operational risk laid out in Basel II:
Challenges with assessing operational riskAssessing and managing operational risk can be difficult given the following:
What are the steps in operational risk management?Some organizations have a formal operational risk management function, while others don't. Those that have them tend to be at different stages of maturity. However, these are the steps companies follow:
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Which of the following best define operational risks?Operational risk is the risk of losses caused by flawed or failed processes, policies, systems or events that disrupt business operations.
What does operational risk management do?Operational Risk Management attempts to reduce risks through risk identification, risk assessment, measurement and mitigation, and monitoring and reporting while determining who manages operational risk. These stages are guided by four principles: Accept risk when benefits outweigh the cost. Accept no unnecessary risk.
What are the 4 main types of operational risk?There are five categories of operational risk: people risk, process risk, systems risk, external events risk, and legal and compliance risk.
Which of the following statements are principles of ORM?Four Principles of ORM
Accept risks when benefits outweigh costs. Accept no unnecessary risk. Anticipate and manage risk by planning. Make risk decisions at the right level.
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