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Operational risk refers to the potential for loss resulting from inadequate or failed internal processes, people, systems, or external events. It is a core risk category faced by all organizations, regardless of size or industry.
What is Operational Risk?
Operational risk is the exposure a business faces when its daily operations do not perform as intended. It includes risks arising from human error, technology failures, fraud, regulatory breaches, natural disasters, and other disruptions.
Definition
Operational risk is the possibility of financial loss or negative impact caused by failures in internal processes, human factors, systems, or external events.
Key Takeaways
- Operational risk exists in every organization and every activity.
- It arises from people, processes, systems, and external influences.
- Strong controls, governance, and risk management frameworks reduce exposure.
- It is one of the key risk categories in enterprise risk management (ERM).
Understanding Operational Risk
Operational risk is unavoidable but manageable. Unlike market or credit risk, which relate to external financial movements, operational risk stems from how a company conducts its internal activities.
Common sources include:
- Human error: Mistakes, misconduct, or insufficient training.
- Process failures: Inefficiencies, bottlenecks, or unclear procedures.
- Systems risk: Software failures, cybersecurity breaches, or IT outages.
- External events: Natural disasters, pandemics, regulatory changes, or supplier failures.
Organizations mitigate operational risk through internal controls, standard operating procedures, audits, compliance programmes, and business continuity planning.
Real-World Example
A bank experiences a technology outage that blocks customers from accessing accounts for several hours. As a result, the bank incurs financial losses, reputational damage, and regulatory scrutiny. This is a clear operational risk event triggered by system failure.
Importance in Business or Economics
Operational risk matters because it:
- Protects businesses from disruptions and financial losses.
- Strengthens operational stability and customer trust.
- Supports regulatory compliance in sectors such as finance and healthcare.
- Helps organizations anticipate vulnerabilities and improve resilience.
Effective operational risk management is essential for sustainable growth and long-term business performance.
Types or Variations
People Risk: Errors, misconduct, turnover, or lack of skills.
Process Risk: Inefficient or failed internal procedures.
Systems Risk: IT breakdowns, cybersecurity issues, automation failures.
External Risk: Natural disasters, geopolitical events, supply chain disruptions.
Legal & Compliance Risk: Violations of laws or internal policies.
Related Terms
- Enterprise Risk Management (ERM)
- Internal Controls
- Compliance Risk
- Cybersecurity Risk
- Business Continuity Planning (BCP)
- Audit and Risk Assessment
Sources and Further Reading
- Basel Committee on Banking Supervision: https://www.bis.org
- Investopedia – Operational Risk: https://www.investopedia.com/terms/o/operationalrisk.asp
- ISO 31000 – Risk Management Standards: https://www.iso.org
- Deloitte – Risk Management Insights: https://www2.deloitte.com
Frequently Asked Questions (FAQs)
Is operational risk the same as compliance risk?
No. Compliance risk is a subset of operational risk focused on regulatory breaches.
Can operational risk be eliminated?
No. It can only be reduced and controlled through strong systems, training, and governance.
Who is responsible for operational risk?
Everyone in the organization plays a role, but ultimate accountability rests with leadership.
