Operational Risks

Operational risks are those risks related to failures in day to day operations. They are different from other kinds of risks such as credit risk, or market risk.

Operational risks are about things going wrong resulting in losses.  For example, a small grocery might encounter the following problems:

• Shoplifters
• Giving too much change to a customer
• A car crashing through the shop
• A customer slipping and hurting themself.
• Goods not the right one
• Counterfeit money
• Robbers
• Fire
• Employee theft

Other kinds of risks are not considered operational risks:

• Another shop opening nearby, drawing some of the customers
• A bank calling on the loan
• Interest rates going up
• Prices of goods going up

Operational risks are about failures of people, systems, and processes, and about external events.

The risk brought about by operational risk, like any risk,  depends on the likelihood of occurrence, and the consequences it brings.  These costs need to be balanced by costs related to mitigating the risk.  For example, the risk of being robbed may be mitigated by hiring guards to secure the store, but will the cost of hiring them be higher than the cost of being robbed, once or twice a year?

The cost of being passed counterfeit bills may be mitigated by installing a counterfeit checking device, but will that cost more?

Operations Risk

Every company faces risks as it goes about its day-to-day operations. 

A bank branch could find itself in the midst of a robbery.  A fastfood restaurant could suddenly have a cook badly burned by an overturned pot filled with boiling water.  A shipping company may have one of its ships boarded by pirates.  A veterinary clinic may have one of its staff or customers bitten by a dog. A data centre may find the building it is located in collapsing due to an earthquake. These risks are called ‘Operations Risk’, or alternatively ‘Operational Risk’. 

The types of operations risk a company faces depends heavily on its line of business, although the nature of risk is that it is often unexpected: the bank could suddenly discover that the pirates who boarded the ship in the above example are actually the bank’s customers.  The shipping company may find its cook burned badly while preparing food.

Operations risk is different from the other types of risks that companies face.  It is not credit risk, which is the risk related to debtors not paying the company.  It is not strategic risk.  It is not market risk.  It is not reputation risk.  Nevertheless, risks arising from operations can cascade into these types of risks.  The revelation that a pirate has been hoarding its loot in your bank can rapidly discredit the bank (reputation risk).