Operational Risk Management in Banking & Financial Institutions
No matter what industry it is, there is a risk in every sector. The banking and finance sectors also witness risks at certain times. They are generally referred to as operational risks, which may include system errors, human errors, improper management, quality issues, and operation-related mistakes.
We are here to give a brief insight into operational risk, its types, and management.
What is an Operational Risk?
Operational risk is the risk of losses caused by failed processes, policies, systems, or events that leads to the devastation of business operations. It is affected and influenced by the procedures and processes that govern, regulate, and manage the operations.
It can also be affected by decisions made by the board of directors and senior management about the organization's priorities and how it functions.
Types of Operational Risk
These are some types of operational risks mentioned below:
People RiskPoor human resource capital management can lead to financial losses and negative performance. It includes the inability to recruit, manage, motivate, and develop qualified resources. It can also lead to fraud or other unethical behavior both within and outside the institution.
Process RiskThis is the risk of financial loss and poor social performance due to failing internal business processes. It can include design flaws in products or internal project failures.
Systems RiskThe risk of financial loss and poor social performance due to failing internal systems is known as Systems Risk. It involves inter-branch connectivity and management information, core banking systems, IT systems, backup systems, and any other technical systems.
External Events RiskFinancial institutions rely on third-party service providers for several projects and tasks. The risk of financial loss and poor performance due to external events not under banks' control. It contains natural disasters like storms, flooding, and earthquakes, as well as man-made ones such as wars and robberies.
Legal and Compliance RiskThis type of operational risk includes tax laws, laws governing human resources, mandatory vehicle registration, codes of ethics conduct internally, and other regulations.
Cybersecurity RisksEven though financial institutions are increasing their cybersecurity efforts, cyber threats, such as ransomware or phishing, have become more common.
How to Identify Operational Risks
The overlap between people, processes, and technology within a bank organization will create operational risks, especially potential human errors.
These should be considered when identifying operational risk using any of the following strategies:
Gather key stakeholders and senior management for a focused session of brainstorming operational risks. These sessions should be used for the identification of operational risks only. Leaders should avoid trying to analyze or resolve the risks.
Audit based on risk
This crucial component of business risk management is essential to help identify operational risks and evaluate the bank's current risk management system. Potential risks can then be plotted on a risk assessment matrix in order to determine their priority.
Identify critical dependencies
Banks might face operational risks every day, but they don't know because they are unaware of their critical dependencies. Critical dependencies are processes and tasks that must be completed in order for a bank to succeed. Banks can be subject to delays, breaches, or other operational risks.
Also Read: How Does a Bank Make Money?
Operational Risk Management in Banking Sector
This phase of managing operational risk should not be rushed and should be conducted patiently. The likelihood that events without fail-safes or protocols will occur increases if you don't identify possible risks. This can lead the bank to risk exposure.
Strategies for Operational Risk Management
Operational risk management is a key component of the banking and financial sector. It can make organizations more profitable and secure. These strategies will help risk managers create an effective operational risk management system.
Assess the Risk Profile
Every financial company must assess its risk profile in order to reduce operational risks and increase information security. The company should assess its strength and use them to mitigate and control risks.
Create key risk indicators
Leadership can be alerted to potential problems by identifying key risk indicators. Real-time testing of controls and operational processes can give visibility into risk factors, such as spikes or areas under stress. These risk indicators can be used by leaders of organizations to help them identify, categorize and mitigate risks.
Training for employees
Employees must be informed about potential risks to ensure the bank's flexible operations. This is particularly important when a business rolls out new products or services or implements business process outsourcing.
Because of the potential impact that a data breach could have on financial organizations' operations, cybersecurity and operational risk are both linked.
Cybersecurity best practices and operational risk management can help these companies develop better plans to prevent or mitigate operational risks.
It is best to ensure that there is a strict quality control process after product processing. This quality control process should be established within the departments. Such quality check plays an important role in the flexible operations of the bank.
This is all about operational risk in the banking sector, its types, and strategies to manage it after identifying potential risks.
In any operation or process, risk is inevitable.
Although this type of risk can be controlled, eliminating it is not always possible. Even with all the efforts in place, there are still possible errors at different steps. However, following best practices and proper management, it can be controlled.
Also Read: What are the top challenges facing the banking industry?