Bankers have reasons to fear operational risks hovering around their businesses. Any loss caused by inadequate or failed internal processes, people, systems, or by external events, can be classified under operational risks.
Basel II has projected seven types of operational risks that banks and financial institutions should bring into focus:
Internal fraud – Acts of fraud committed internally in an organization go against its interest. Losses can result from intent to defraud, tax non-compliance, misappropriation of assets, forgery, bribes, deliberate mismarking of positions and theft.
External fraud – External frauds are activities committed by third parties. Theft, cheque fraud, and breaching the system security like hacking or acquiring unauthorized information are the frequently encountered practices under external fraud.
Employment practices and workplace safety – Non-compliance to employment or health-and-safety laws and regulations are grave operational hazards in any organization.
Incompetent maintenance of employee relations takes a toll on employees, claiming their well-deserved compensation and benefits. Unethical termination criteria and discrimination are other operational risks that subject institutions to serious financial and reputational damage.
Clients, products, & business practice – Organizations fail to meet promises made to their clients as a result of unintended circumstances rising from negligent practices. Privacy and fiduciary breaches, misuse of confidential information, suitability issues, market manipulation, money laundering, unlicensed activities and product defects are very common practices that lead companies to face lawsuits.
There are many intentional and unintentional malpractices exercised in the business world. Entrepreneurs should learn the do’s and don’ts before starting up.
Damage to physical assets – These are losses incurred by damages caused to physical assets due to natural disasters or other events like terrorism and vandalism. Rapid and unexpected changes in climatic conditions have been a constant cause of concern in the business world for more than a decade in recent history.
Business disruption and systems failures – Supply-chain disruptions and business continuity have always been a big challenge for banks. System failures (hardware or software), disruption in telecommunication, and power failure can all result in interrupted business and financial loss.
Execution, delivery, & process management – Failure in delivery, transaction or process management is an operational risk that has the potential to bring loss to a business.
Errors in data entry, miscommunication, deadline misses, accounting errors, inaccurate reports, incorrect client records, negligent loss of client assets and vendor disputes are operational risk events that could bring about legal threats to the organization.
Operational risks can be mitigated efficiently if bankers learn the core operational vulnerabilities of their businesses, and set the risk indicators accordingly. And the right way of dealing with it is to educate employees to analyse and manage operational risks on a daily basis.
Operational risk causes are evolving periodically and banks need to develop an innovative eye to tackle them. Poor management of operational risks can also damage the credibility, reputation and finances of an organization.