Key Steps to Manage Operational Risk

As the repercussions of the Covid-19 pandemic linger, many organizations are still concerned about the pandemic’s long-term effect on business operations, continuity, and service delivery.

Senior leaders must manage operational risk to mitigate those effects today, and to protect the organization from other unexpected shocks in the future. If executives don’t do that job well, their missteps could lead to risk events that disrupt operations, hurt the bottom line, and perhaps even cause organizational failure.

In this article, we share some key strategies for optimal operational risk management in a post-Covid world.

The Impact of Covid-19 on Operations and Supply Chains

For many years, pandemics were a low priority in the threat catalogs of corporate organizations. Then came Covid-19, and within a matter of weeks those same organizations had to revise their operating objectives and procedures dramatically.

Specifically, business continuity pushed aside cost-cutting, efficiency, and productivity as a top organizational concern. Now continuity is likely to stay a top concern for many years to come.

In this challenging landscape, organizations must find ways to assure operational continuity. To do that, it’s crucial to manage operational risk.

What Is Operational Risk?

Before unpacking the risk management process, let’s first understand what “operational risk” really means. Simply put, operational risk is the risk of losses resulting from disruptions to business processes and internal operations.

Considered a subset of enterprise risk management, operational risk can result from:

• A breakdown in internal procedures
• Human error
• Disruption to business practices
• System failures
• External events (such as natural disasters or, yes, a pandemic)
• Inadequately trained staff
• Employees’ participation in fraudulent activities
• Cyberattacks and data breaches

In general, operational risk can come from:

• Technology
  • Hardware
  • Software
  • Cybersecurity
  • Privacy
• People
  • Employees
  • Vendors
  • Customers
  • Other stakeholders
• Regulatory and compliance demands

The practical upshot: ongoing operational risk management is essential to minimize the threat of operational risks.

What Is the Objective of Operational Risk Management?

Any operational risk can impose financial costs, either from goods and services not delivered to customers or extra expenses for your employees to handle the disruption. Operational risk can also have other repercussions more difficult to quantify. For example, disruptions to your delivery schedule might tarnish the organization’s reputation with customers. If you are able to effectively manage operational risk, you can mitigate those second-order effects of reputational and financial risks.

So how do we go about solving this problem? The following section describes a step-by-step process breakdown for effective operational risk management.

A Five-Step Process for Effective Operational Risk Management

You can never eliminate operational risk completely, so operational risk management (ORM) focuses on reducing and mitigating key risks related to the organization’s day-to-day operations. ORM never ends, since operational risks are constant, pervasive, and varied. The ORM process includes five stages.

1. Risk Identification

   Identifying operational risks in the context of the organization’s objectives and goals is the natural first step to risk mitigation and reduction.

2. Risk Assessment

   After all the operational risks are identified, evaluate them based on the potential harm and likelihood of occurrence. This activity helps the organization to understand which risks should be prioritized, and why.

3. Risk Measurement and Mitigation

   In this stage, compare the cost of risk control to the cost of potential risk exposure. Then choose how to mitigate the risk:

   • Transfer the risk to a different organization, such as an insurance company;
   • Avoid the risk, such as by choosing a vendor with more robust internal controls for cybersecurity;
   • Accept the risk if the benefits outweigh the costs;
   • Control the risk to decrease its harm.

4. Control Implementation

   Implement the necessary controls to mitigate or minimize the risk.

5. Risk Monitoring and Reporting

   Monitor the risks continuously to determine whether there are any changes to their prevalence and severity. Your original list of identified risks should be reviewed and updated on a regular basis.

Operational Risk Management: Four Guiding Principles

The operational risk management process is guided by four principles.

1. Accept No Unnecessary Risk

   Any risk that will not contribute meaningfully to the task, project, or objective is unnecessary and may even jeopardize the organization. Such risks should not be accepted.

2. Accept Risk When Benefits Outweigh Costs

   If the sum of benefits clearly outweighs the sum of costs, the risk should be accepted. If the costs outweigh the benefits, the risk should be rejected.

3. Make Risk Decisions at the Appropriate Level

   The person(s) in the appropriate decision-making role should understand the risk, allocate the right resources to reduce it, and implement the necessary controls.

4. Anticipate and Manage Risk by Planning

   Plan thoroughly to identify possible future risks and create a mitigation plan.

Operational Risk Management Challenges

Managing operational risk depends heavily on your organization’s ability to understand the issues involved and to adopt ORM throughout the organization. Some of the most common challenges organizations face in determining and mitigating operational risk are listed below.

• Aligning operational risk management within the aggregate enterprise risk strategy
• Failure to continuously monitor and detect new risks
• Continued use of legacy technologies
• Lack of funding, resources, and poor communication

For an in-depth understanding of these challenges, we put together a guide outlining these challenges to operational risk management in a separate article. So how do we overcome these challenges while preparing for operational risk? The next section discusses best practices in ORM.

Operational Risk Management: Best Practices

Even though ORM is a compelling idea, several barriers make it challenging to manage operational risk: competing priorities, a lack of awareness, difficulty allocating resources, and an inability to perceive value in the operational risk framework.

The lack of standardized risk assessment processes and measurement methodologies, as well as complex ORM programs, can also hinder organizations’ ability to manage operational risk.

Nonetheless, by following these five best practices, enterprises can effectively manage operational risk initiatives and assure business continuity:

1. Implement Risk Accountability

   Every employee must be held accountable for risk management, although the extent for each individual can vary. Enterprise-wide accountability helps incorporate integrated risk management elements into day-to-day activities and promotes a beneficial risk-aware culture.

2. Champion ORM From the Top

   Senior management must champion the risk management program for it to be truly effective.

3. Conduct Timely Risk Assessments

   Regular risk assessments help keep the enterprise risk profile and key risk indicators up-to-date and allow ORM leaders to incorporate relevant changes without unnecessary delays.

4. Quantify and Prioritize Risks

   All operational risks must be quantified in their probability, severity, and mitigation costs.

5. Implement Strong Controls

   Controls and metrics help with the ongoing management and active mitigation of identified priority risks. Automation and artificial intelligence tools can perform continuous control self-assessment and monitoring to reduce manual work.

These best practices are a perfect starting point for any type of business. Individual industries may have additional considerations, whether that’s a financial services institution trying to reduce operational risk or a manufacturing facility looking to maintain business continuity.

Manage Operational Risk With ROAR

Evaluating your operational risks, developing internal controls, and creating documentation every step of the way can be cumbersome and time-consuming if you’re trying to do it all manually via spreadsheets.

The Reciprocity^® ROAR Platform can enable you to streamline operational risk management by automating many of these manual tasks.

ROAR offers easy-to-use operational risk management templates that empower you to evaluate risk on a comprehensive level. At the same time, our user-friendly dashboard shows you where your gaps are and where you’re doing well, so you are always aware of your risk posture.

Say goodbye to the burden of operational risk management, and find your zen. Schedule a demo of our software today to learn more.