Operational risk refers to the potential for losses arising from inadequacies or failures caused by people, systems, internal processes, or external events. It is the risk inherent in an organization’s daily activities, a factor that distinguishes it from strategic and financial risks.
This type of risk is not systematic and is not linked to just one type of company or industry. It permeates every organization and can lead to both direct financial losses and indirect damage to its reputation.
The Operational Risk Management (ORM) is the practice of proactive identification, followed by the assessment and mitigation of these risks. Its main objective is to protect the organization by reducing risks to an acceptable level through the use of a structured framework.
In this article, we will explore the main sources of operational risk, detail the most common types, and present the key metrics to measure and monitor them effectively.
What is the difference between operational, strategic, and financial risks?
Within the complex scenario of corporate risk management, it is crucial to differentiate between the primary categories that can impact your organization. They are often connected, but originate from different sources and require distinct management approaches.
Understanding these distinctions is the first step towards creating a focused and effective risk management framework. Confusion between these types of risks can lead to incorrect resource allocations and inadequate mitigation strategies.
A problem rooted in daily operations cannot be solved with a high-level strategic change. Likewise, a financial liquidity crisis will not be fixed by simply improving internal controls.
Operational Risk
Operational risk is the risk of losses resulting from the execution of a company’s business functions. It concerns internal failures related to people, processes, and systems — as well as external events that disrupt daily operations.
Examples include employee errors, technology failures, internal fraud, and supply chain disruption due to a natural disaster. Operational risk concerns how tasks and operations are executed within an organization.
The management of this type of risk is inherently defensive, focusing on creating resilience through the control of internal procedures. This protects the company’s profitability and its reputation against the threat of operational failures.
Strategic Risk
Strategic risk is the potential for losses arising from unsuccessful business strategies or the failure to adapt to changes in the external environment. It encompasses long-term decisions about the company’s direction.
These decisions include things like entering new markets, launching new products, or responding to new competitors. Its management is, by definition, linked to the board of directors and c-level decision-making.
Unlike operational risk, which concerns execution, strategic risk is about the company’s direction itself. A company often takes a strategic risk voluntarily to pursue a greater reward, but mistakes in this area can lead to a significant loss of market share.
Financial Risk
Financial risk specifically refers to the possibility that the company’s cash flow will prove inadequate to meet its financial obligations, such as the payment of loans and other debts. It primarily concerns factors such as capital structure, liquidity, and exposure to financial market variables (such as interest rates and currency fluctuations).
Operational problems can lead to financial difficulties, but financial risk is distinguished by its focus on debt financing and monetary leverage. It assesses whether the company can remain solvent, even if its daily operations are not going well.
Therefore, the fundamental difference between these three risks lies in their focus:
- Operational risk concerns the internal functioning of the company.
- Strategic risk is about the organization’s direction and long-term choices.
- Financial risk deals with the company’s financial health and structure.
A resilient organization must have dedicated strategies to monitor and manage these three types of risk together.
Read more: What is supply chain risk management software, and how to choose the best one
What are the seven types of operational risk that every business faces?
Operational risk is not a monolithic threat, but rather a category composed of several distinct and interconnected vulnerabilities. To manage it effectively, one must first understand the main ways it manifests itself.
They are divided into seven main types, which will allow for a comprehensive mapping of the operational risk landscape. They are often categorized by frameworks such as the Basel Committee on Banking Supervision (BCBS).
The ability to recognize these categories will allow your business to move from a reactive to a proactive posture, enabling the implementation of targeted controls for each specific area. This prevents threats from being missed amid the complexity of daily operations.
These are the seven main types of operational risk that every business faces:
- Internal Fraud. Represents losses derived from fraud by internal parties. For example, it could be an employee intentionally ignoring internal controls to embezzle assets, commit theft, or engage in malicious activities for personal gain.
- External Fraud. Involves losses caused by external parties committing crimes against the organization. Includes cyberattacks, theft, forgery, and systematic attempts to bribe employees to gain an undue advantage.
- Technological Failures. Encompasses losses arising from interruptions in the functioning of hardware, software, and other critical interfaces between them. It could be a simple server crash or significant system bugs that result in security failures or production line shutdowns.
- Delivery Issues. Also includes difficulties in process management and occurs when internal workflows are inefficient, flawed, or poorly executed. This happens when management fails to assess the situation correctly and employs the wrong strategy, leading to operational bottlenecks.
- Worker Safety. Covers risks related to the well-being and management of employees. It deals with violations of safety protocols, inadequate working conditions that affect employee health, and disputes arising from unfair labor practices.
- Natural Disasters. Threat of operational interruptions from environmental events. Occurrences such as fires, floods, and earthquakes can damage critical infrastructure and prevent workers from performing their tasks.
- Clients, Products, and Business Practices. Involves losses resulting from negligently or unintentionally causing harm to customers or partners. Includes selling defective products, sharing misleading information, or failing to comply with regulatory requirements. All of this can lead to lawsuits and damage to reputation.
Understanding these seven types of operational risk is fundamental to building a resilient organization. By systematically addressing each of these categories, your company can develop a robust defense against uncertainties that threaten its growth and stability.
Continue reading: What is Third-Party Risk Management and what makes it essential
What metrics to use to measure operational risks?
Effective operational risk management depends on your organization having the courage to abandon qualitative fears and embrace quantitative facts. Without concrete data, it is impossible to assess risk exposure, prioritize resources, or demonstrate the effectiveness of your mitigation efforts.
With the right metrics, your team can anticipate and avoid financial losses. They function as an early warning system and offer a consistent language for reporting risks to senior managers and directors.
By tracking the right indicators, organizations can adopt proactive risk management. This ensures that decisions are informed, timely, and aligned with the company’s strategic objectives.
Key Risk Indicators (KRIs)
Also known as Key Risk Indicators, KRIs are prospective metrics that signal an increase in risk exposure across various areas of the organization. They allow you to receive alerts before a significant risk event materializes.
Examples of KRIs are the number of IT security incidents, employee turnover rate, and the number of pending transaction processing items. Unlike what often happens with Key Performance Indicators (KPIs), KRIs allow management to intervene in advance.
Risk and Control Self-Assessment (RCSA)
With an English acronym meaning “Risk and Control Self-Assessment”, this is the fundamental process of documenting and assessing the organization’s operational risks. By assessing the controls designed to mitigate these risks, your business units can use RCSA to identify their key risk exposures and the effectiveness of the activities to contain them.
The outcome of this self-assessment is a comprehensive risk register that paints a clear picture of the company’s profile. The Risk and Control Self-Assessment process promotes accountability by assigning owners to specific risks.
It requires an assessment of both inherent risk (before controls) and residual risk (after controls). This continuous assessment helps define a budget for initiatives in the area and ensures that the entire organization has a constant understanding of its key risks.
Risk Matrix
The risk matrix is a visual tool used to map and prioritize identified risks based on their likelihood of occurrence and their potential impact. Creating a common scale allows the organization to compare distinct risks on a single chart.
This visualization makes it easy to communicate to stakeholders which risks require attention and immediate resource allocation. The matrix often categorizes risks into zones, such as green (acceptable), yellow (requires monitoring), and red (requires immediate action).
This prioritization is crucial for the risk mitigation stage, as it ensures that the most severe and likely threats receive attention first. The result is a better-optimized allocation of resources.
GRC Technology
Modern Governance, Risk, and Compliance (GRC) platforms leverage specialized software to automate and integrate risk management processes. These systems consolidate data from risk assessments, control activities, and compliance monitoring into a unified framework.
These solutions offer continuous monitoring capabilities and generate real-time compliance reports, using automated alerts and centralized dashboards. This allows organizations to maintain continuous regulatory adherence, streamline their audit preparation, and support strategic decision-making with consolidated risk intelligence.
This is the case with SoftExpert GRC, an AI-powered platform that centralizes and automates governance, risk, and compliance activities. The solution offers a single source of truth by integrating data from risk assessments, control monitoring, and audit findings, replacing manual and disconnected processes.
A robust measurement system for operational risk does not rely on a single metric, but on a synergistic set of tools. KRIs provide the early signals, RCSA provides the structured assessment, and the Risk Matrix allows for clear prioritization. To complete it, GRC technology brings it all together with efficiency and advanced insights.
Together, these metrics empower an organization to master its risks.
Conclusion
Operational risk is a determining factor for the resilience and longevity of any company. To master it, it is necessary to go beyond simple compliance and embrace a culture of vigilance focused on continuous improvement.
The integrated use of KRIs, RCSA, and risk matrices will give you the necessary structure to anticipate and control these threats. When powered by modern GRC technology like SoftExpert GRC, this approach transforms risk management into a strategic enabler.
Ultimately, a robust operational risk management program will protect your assets and build a foundation for gaining stakeholder trust. Organizations that excel in this discipline are not only more secure but are also better positioned for sustainable growth.
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FAQ – Frequently Asked Questions about operational risk
Next, we will answer the most common questions about the topic of operational risk:
Operational risk is the possibility of losses resulting from failures in people, processes, systems, or from external events that impact a company’s daily operations. It is considered an “invisible enemy” because it is intrinsically linked to the organization’s routine activities, potentially arising in subtle and unexpected ways, making it a constant and not always apparent threat.
The main sources include human failures, such as errors or internal fraud, and inadequacies in processes or technology systems. Additionally, unpredictable external events, such as natural disasters or disruptions in the supplier chain, also represent significant sources of risk that can paralyze operations.
Effective measurement can be done through Key Risk Indicators (KRIs), which signal increased risk exposure, and the Risk and Control Self-Assessment (RCSA), which identifies and evaluates the effectiveness of internal controls. Tools such as the risk matrix to prioritize threats and Governance, Risk, and Compliance (GRC) platforms to consolidate data are also essential for continuous and proactive monitoring.
Neglect can lead to direct financial losses, resulting from fraud or operational shutdowns, and indirect and often irreparable damage to reputation and stakeholder trust. Companies that fail to proactively manage these risks become vulnerable to crises that can compromise their long-term stability and growth.
