Operational risk

Operational risk - the risk of errors in transactions carried out, the risk of loss resulting from inadequacy or failure of internal processes (people and technical systems) or from external events. Operational risk is not directly related to market volatility or the creditworthiness of counterparties. It is often claimed that this type of risk includes everything that is not classified as other risks.

Sources of risk

Sources of operational risk include:

• Domestic abuse: theft carried out by employees, forgery and other fraud,
• External fraud: robbery, theft, burglary
• Terms of employment and safety in the workplace: discrimination, employee dissatisfaction, poor working conditions.
• Business practices: the use of confidential customer data, money laundering, the sale of unauthorized products
• Destruction of assets: vandalism, terrorism and unexpected events,
• Lack of business continuity - interruption of production, problems with the hardware, connectivity and software,
• Management of the institution - process management, data entry errors, incomplete legal documentation, complaints.

Types of market risks

Due to the nature of the above risks, operational risks can be divided into four categories:

• Risk of relations with the environment
• Staff risk
• Technological risk
• Documentation risk.

Risk of relations with the environment - this is a risk of loss of reputation of the institution. Typically, in this case the negative opinion translates to a loss of consumer confidence, reduced profits or loss of liquidity. This may be related to the complaints, lawsuits and unfavorable press releases.

Staff risk - this is a risk of a situation where an employee intentionally or unintentionally acts to the detriment of the institution.

Technological Risk - the risk is mainly related to information systems and accounting.

Documentation risk - is the risk associated with storing documents in the wrong place, the possibility of unauthorized access to secret information, and documentation of transactions in the wrong way

Methods of operational risk mitigation

Operational risk can be minimized by:

• Well-prepared and well-functioning internal control,
• Independent and objective audit,
• Effective supervision which can identify many internal problems.

See also:

• Risk management

Operational risk — recommended articles

Technical risk — Operational impact — Transfer of risk — Specific risk — Accident management — Indirect loss — Hostile takeover — Internal check — Inherent risk

References

• Cruz, M. G. (2002). Modeling, measuring and hedging operational risk. Chichester: Wiley.
• Michalski, G. (2009). Inventory management optimization as part of operational risk management. Economic Computation and Economic Cybernetics Studies and Research, 213-222.
• Chavez-Demoulin, V., Embrechts, P., & Nešlehová, J. (2006). Quantitative models for operational risk: extremes, dependence and aggregation. Journal of Banking & Finance, 30(10), 2635-2658.