Operational Risk Management (ORM) and Enterprise Risk Management (ERM) are two important processes that help organizations identify, assess, and mitigate risks. While ERM is a holistic approach that covers a wide range of risks with the goal of finding a balance of risk and reward, ORM focuses specifically on protecting the organization from losses caused by internal and external factors. The process typically includes five steps: identifying risks, assessing likelihood and impact, mitigating risks, monitoring controls, and reporting activities to senior management.
What Is Operational Risk in GRC Management?
Operational risk is the risk of loss resulting from ineffective or failed internal processes, people, systems, or external events that can disrupt the flow of business operations. It can refer to both the risk in operating an organization and the processes management uses when implementing, training, and enforcing policies. Operational risk management is a subset of enterprise risk management that focuses on protecting the organization from losses caused by internal and external factors, while excluding strategic, reputational and financial risks. It can be viewed as a chain reaction of overlooked issues and control failures that lead to greater risk materialization, which may result in an organizational failure that can harm a company’s bottom line and reputation.
This risk is a common threat that can cause financial losses and disrupt the flow of business operations. The goal of operational risk management is to focus on the risks that have the most impact on the organization and hold employees accountable for managing them.
Examples of operational risk include:
- Employee conduct and employee error: Employee conduct and errors can lead to financial losses, damage to reputation, and regulatory fines. For example, a poorly trained employee may lose a sales opportunity, or an employee may intentionally or unintentionally disclose confidential information.
- Breach of private data resulting from cybersecurity attacks: Cybersecurity attacks can lead to data breaches, loss of confidential information, and damage to reputation. For example, a hacker may gain access to sensitive customer data, or a ransomware attack may encrypt critical data and demand a ransom.
- Technology risks tied to automation, robotics, and artificial intelligence: Technology risks can lead to operational disruptions, financial losses, and damage to reputation. For example, a software bug may cause a system failure, or a robot may malfunction and cause an accident.
- Business processes and controls: Business processes and controls can be affected by operational risks, leading to financial losses, damage to reputation, and regulatory fines. For example, a lack of proper controls may lead to fraud, or a lack of compliance may lead to fines.
- Physical events that can disrupt a business, such as natural catastrophes: Physical events can lead to operational disruptions, financial losses, and damage to reputation. For example, a natural disaster may cause a power outage, or a fire may destroy a facility.
- Internal and external fraud: Fraud can lead to financial losses, damage to reputation, and regulatory fines. For example, an employee may embezzle funds, or a vendor may invoice for goods or services that were not delivered.
GRC: How Does Operational Risk Management Work?
Operational risk management is a process that aims to reduce risks to an acceptable level by identifying, assessing, measuring, mitigating, monitoring, and reporting on all aspects of an organization's objectives.
Risk Identification is the first step in Operational Risk Management and involves identifying all potential risks that could negatively impact the organization's operations. This includes identifying risks related to processes, systems, people, and external factors. To ensure completeness, a control framework should be used or developed to guide the identification process.
Risk Assessment follows the identification of risks, and involves evaluating the impact and likelihood of each identified risk. This allows risks to be prioritized and ranked relative to one another.
Measurement and Mitigation
Measurement and Mitigation is the next step, in which the risks are measured against a consistent scale to allow for proper prioritization and decision making. This also includes considering the cost of controlling the risk in relation to the potential exposure.
Monitoring and Reporting
Monitoring and Reporting are the final steps in the risk management process. Risks are monitored over time to detect any changes and reported to senior management and the board to facilitate decision-making processes. This ongoing monitoring and reporting allows the organization to proactively address emerging risks and make informed decisions to mitigate potential risks.
Governance, Risk and Compliance: What Is the Primary Objective of ORM?
The primary objective of ORM is to eliminate or minimize risks that could negatively impact the organization's operations.
It differs from other risk management disciplines, such as Enterprise Risk Management (ERM), which focuses on optimizing risk appetites and balancing risk-taking with potential rewards.
The framework starts with identifying risks and deciding on a mitigation scenario. It proactively seeks to protect the organization by eliminating or minimizing risk. The scope of operational risk can vary depending on the organization and can include fraud, technology, and financial risks.
The Risk Management Association defines operational risk as the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events, but is better viewed as the risk arising from the execution of an institution’s business functions.
Applying a control framework, whether a formal framework or an internally developed model, helps when designing internal control processes. One approach to understanding how these processes look in your organization is by organizing operational risks into categories like people risks, technology risks, and regulatory risks.
People: Operational risk related to people includes risks associated with employees, customers, vendors and other stakeholders. Employee risk includes human error and intentional wrongdoing, such as in cases of fraud. Risks include breach of policy, insufficient guidance, poor training, bad decision making, or fraudulent behavior. Employees, customers, and vendors can also pose a risk through their interactions with social media. To mitigate these risks, organizations must have effective monitoring and control processes in place to detect and respond to potential issues.
Technology: Technology risk from an operational standpoint includes hardware, software, privacy, and security. Hardware limitations can hinder productivity, especially when in a remote work environment. Software too can reduce productivity when applications do increase efficiency or employees lack training. Software can also impact customers as they interact with your organization. External threats exist as hackers attempt to steal information or hijack networks. This can lead to leaked customer information and data privacy concerns. To mitigate these risks, organizations must have robust cybersecurity measures in place and ensure software is up to date and employees are trained to use it.
Regulations: Risk for non-compliance to regulation exists in some form in nearly every organization. Some industries are more highly regulated than others, but all regulations come down to operationalizing internal controls. Over the past decade, the number and complexity of rules have increased and the penalties have become more severe. Organizations must have a good understanding of the regulations that apply to them and implement effective internal controls to ensure compliance. This includes regular monitoring and reporting to ensure compliance is maintained over time.
ORM and Enterprise Risk Management (ERM) both address risks in the same areas, but they have different approaches and objectives. While ORM focuses on controls and eliminating risk, ERM emphasizes optimizing risk appetites to balance risk-taking and potential rewards. In order to consolidate these disciplines and address risk from a holistic perspective, some organizations have implemented Integrated Risk Management (IRM). IRM addresses risk from a cultural point of view and allows organizations to implement technology with different parameters for teams like ERM and ORM depending on the objective of the particular risk practice.
GRC Processes: Operational Risk Management
The Operational Risk Management (ORM) process is a systematic approach to identifying, assessing, and controlling risks that may impede an organization's ability to achieve its objectives. The ORM process typically consists of the following five steps:
- Risk Identification: Risks must be identified so they can be controlled. Risk identification starts with understanding the organization's objectives. Risks are anything that prevents the organization from attaining its objectives.
- Risk Assessment: Risk assessment is a systematic process for rating risks on likelihood and impact. The outcome from the risk assessment is a prioritized listing of known risks. The risk assessment process may look similar to the risk assessment done by internal audit.
- Risk Mitigation: The risk mitigation step involves choosing a path for controlling specific risks. In the ORM process, there are four options for risk mitigation: transfer, avoid, accept, and control.
- Control Implementation: Once the risk mitigation choice decisions are made, the next step is implementation. The controls are designed specifically to meet the risk in question and should be clearly communicated and executed.
- Monitoring: Since the controls may be performed by people who make mistakes, or the environment could change, the controls should be monitored. Control monitoring involves testing the control for appropriateness of design, implementation, and operating effectiveness.
Any exceptions or issues should be raised to management with action plans established. Some organizations may also adopt continuous monitoring/early warning systems built around key risk indicators (KRIs) to provide early signals of increasing risk exposures.
In the monitoring step of Operational Risk Management, some organizations use Key Risk Indicators (KRIs) as a powerful tool to provide early warning signals of increasing risk exposures in various areas of the enterprise. KRIs are metrics used to monitor potential risks and send notifications when there are any issues, this allows organizations to quickly identify and address them before they become major problems.
The concept of KRIs can be applied to any industry, for example, in the financial industry, KRIs are designed around ratios that are monitored by business intelligence applications, while in the retail industry, it could be customer satisfaction scores. This approach is particularly useful in the financial industry to detect potential issues and take action before they become major problems.
Governace Risk and Compliance Future: Challenges and Shortcomings of Operational Risk Management?
Operational Risk Management (ORM) is a critical function in organizations as it helps to identify, assess, and control risks that may impede an organization's ability to meet the demands of customers and stakeholders. However, it is also one of the most tenuous links in an organization's ability to meet these demands due to various challenges and shortcomings.
One of the most common challenges is the perception that organizations do not have sufficient resources to invest in these processes. This can lead to a lack of commitment to developing and maintaining an effective ORM program. Additionally, there is a need for greater communication and education around his importance and the consequences of operational failures on a company's bottom line.
Another challenge is the lack of understanding and appreciation of ORM among boards and C-suite executives. Without a clear understanding of the steps involved in ORM, it can be difficult to secure the necessary support and resources for the program.
Another issue is the lack of consistent methodologies to measure and assess risk, which can make it difficult to provide an accurate portrait of an organization's risk profile. Additionally, establishing standard risk terminology that will be used moving forward is crucial for successful Risk and Control Self-Assessments (RCSAs).
The process can also be complicated by changes in technology, making it difficult to keep up with the latest developments and trends. Furthermore, the function of ORM is oftentimes lumped in with other functions such as compliance and IT, which can lead to it not receiving the significant attention it requires.
Strong Operational Risk Management: Benefits for a GRC System
A strong program can provide a wide range of benefits for organizations. By effectively identifying, assessing, and mitigating operational risks, organizations can better achieve their strategic objectives while also ensuring business continuity in the event of disruptions to operations.
Some of the key advantages include:
- Better C-suite visibility: ORM provides a holistic view of an organization's risk profile, allowing C-suite executives to make more informed decisions about the direction of the business. This increased visibility can help organizations identify potential risks before they become major problems, allowing executives to take proactive measures to mitigate those risks.
- Better informed business risk-taking: With a better understanding of their risk profile, organizations can make better-informed decisions about the risks they are willing to take. This can lead to more successful business ventures, as the organization is better equipped to identify and manage potential risks.
- Improved product performance and better brand recognition: Organizations that can effectively manage operational risks are better positioned to meet the demands of their customers and stakeholders, which can lead to stronger relationships and greater customer satisfaction. This can also lead to improved brand recognition, as customers will have more confidence in the company's ability to deliver high-quality products and services.
- Stronger relationships with customers and stakeholders: By effectively identifying and managing operational risks, organizations can build stronger relationships with their customers and stakeholders, leading to greater customer loyalty and stronger partnerships.
- Greater investor confidence: Investors want to see that a company is taking steps to manage its risks and is prepared for any potential disruptions to operations. This can lead to better financial performance and more sustainable financial forecasting.
- Better performance reporting: By effectively identifying and assessing risks, organizations can more accurately report their performance and provide a more complete picture of their risk profile to stakeholders. This can help organizations identify potential risks and take proactive measures to mitigate them.
- More sustainable financial forecasting: Effective management of operational risks can help organizations make more accurate financial forecasts, leading to more sustainable financial performance and greater investor confidence.
GRC Management: How to Develop an Operational Risk Management Program?
Developing an operational risk management program for an organization is a crucial step in ensuring the long-term success and stability of the organization. The following are some key steps and considerations to keep in mind when creating an operational risk framework and program:
- Promoting an organization-wide understanding of the program’s value and function: It is important to create awareness and educate all employees on the significance and purpose of operational risk management and how it affects the organization.
- Leveraging technology to implement an automated approach to monitoring and collecting risk data: Automation can improve the efficiency and accuracy of identifying and tracking risks by using technology.
- Establishing an effective method for evaluating and identifying principal risks in the organization and a way to continuously identify and update those risks and associated measures: To effectively manage operational risks, it is important to have a method in place to evaluate and identify key risks, and also have a process to monitor and update them.
- Focus on helping the organization reduce material risk exposures while encouraging activities where the potential business benefits outweigh the risks: The goal of operational risk management is to minimize the negative impact of risks while allowing the organization to capitalize on opportunities.
- Partnering ORM with other functions in the organization to better embed best practices into the organization: Collaborating with other departments such as compliance, legal and IT helps ensure that the operational risk management program is integrated into the organization's overall risk management strategy and best practices are followed.
RIsk and Compliance Processes: The Risk and Control Self-Assessment
The program is an essential component of any organization's overall risk management strategy. It begins with the risk management team working closely with business process owners to identify and assess the risks and controls within the organization. One of the first steps in understanding the nature of operational risks in an organization is through a Risk and Control Self-Assessment (RCSA).
The Risk and Control Self-Assessment (RCSA) is a framework that allows organizations to understand and manage operational risks by identifying and assessing risks and controls, analyzing the organization's operational risk profile, and developing a plan for managing risk. It is an important part of an organization's overall operational risk management strategy and should be conducted at the business-unit level for best results.
To ensure the effectiveness of the RCSA, it is important to follow some industry best practices:
- Integrate these programs into your operational risk initiatives. This will ensure that the RCSA is aligned with the overall risk management strategy of the organization.
- Establish a standard risk terminology and consistent methodologies to measure and assess risk. This will ensure consistency and accuracy of the risk assessment process.
- Develop a complete view of risks and controls. This will ensure that all risks and controls are identified and assessed, providing a comprehensive picture of the organization's operational risk profile.
- Incorporate a trend analysis methodology into the RCSA. This will allow for identifying patterns in risk and potential control failures.
- Incorporate a method for identifying non-financial risks that may have impacts that can harm the organization's bottom line.
- Use the RCSA to budget for operational risk management initiatives. This will ensure that the organization has the resources it needs to effectively manage operational risks.
Operational Risk Management: GRC Tools and Resources
In today's digital age, technology plays a crucial role in the implementation and management of these processes. By leveraging technology and tools, organizations can increase the value and drive better business decisions and gain a competitive advantage.
One of the key benefits of using technology is the ability to build a library of risks and controls and automate the risk assessment process. By implementing a risk management application, organizations can easily document, track and analyze risks, and ensure that the risk management process is applied consistently across the organization. This can help organizations to identify potential risks early on and take proactive measures to mitigate them.
Another benefit of using technology in an operational risk management program is the ability to embed the processes with technology. This ensures that the integration into the organization's overall risk management strategy and best practices are followed. This can help organizations to better manage operational risks and comply with regulatory requirements such as SOX and cybersecurity compliance.
Technology can also be used to support operational audits and risk library management. By using technology, organizations can automate the process of collecting and analyzing data, which can help to identify potential risks and control weaknesses. This can help organizations to identify potential risks early on and take proactive measures to mitigate them.
Risk Compliance Guide for Financial Institutions
A financial company should take the following steps to be compliant with the regulations stated in the text:
- Risk Identification: Understand the organization's objectives and identify any risks that could prevent the organization from achieving these objectives.
- Risk Assessment: Systematically rate risks on likelihood and impact, and create a prioritized list of known risks.
- Risk Mitigation: Choose a path for controlling specific risks by evaluating options such as transferring, avoiding, accepting, or controlling the risk.
- Control Implementation: Design and implement controls that are specific to the identified risks and document the rationale, objective, and activity of the controls.
- Monitoring: Test the controls for appropriateness of design, implementation, and operating effectiveness, and establish action plans for any exceptions or issues that arise.
In addition, financial companies should also adopt continuous monitoring/early warning systems built around key risk indicators (KRIs) to provide an early signal of increasing risk exposure.
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