Classification of Operational Risk

Operational risk refers to the potential for loss resulting from inadequate or failed internal processes, people, systems, or from external events. To effectively manage and mitigate these risks, financial institutions and other organizations categorize operational risk into specific types. This classification aids in identifying risk sources, designing control mechanisms, and enhancing overall operational resilience.

Key Categories of Operational Risk

1. Internal Fraud
   Losses arising from acts of a fraudulent nature committed by individuals within the organization, such as theft, embezzlement, or unauthorized transactions.
2. External Fraud
   Losses caused by external parties, including cyberattacks, forgery, data breaches, and other forms of fraud perpetrated by customers, vendors, or other third parties.
3. Process Failures
   Risks resulting from errors or failures in internal processes. This includes mistakes in transaction processing, data entry, record-keeping, and reporting.
4. Technology Failures
   Operational disruptions stemming from failures or malfunctions in IT systems, hardware, or software, which can impair business continuity and cause financial loss.
5. People Risk
   Risks associated with human factors such as employee misconduct, inadequate training, errors in judgment, or breaches of workplace safety protocols. This also includes risks from poor labor relations or staffing issues.
6. Damage to Physical Assets
   Losses due to damage or destruction of physical assets—including buildings, equipment, or inventory—caused by natural disasters, accidents, or acts of vandalism.
7. Clients, Products, and Business Practices
   Risks associated with improper business conduct, including mis-selling of products, breach of fiduciary duty, unfair competitive practices, or failure to meet product quality standards, which can lead to customer dissatisfaction or legal action.
8. Business Disruption and System Failures
   Risks linked to unplanned interruptions of business operations, such as power outages, natural disasters, system downtime, or supply chain disruptions.
9. Legal and Compliance Risk
   Risks arising from non-compliance with applicable laws, regulations, or contractual obligations, potentially leading to legal penalties, sanctions, or reputational damage.
10. Reputational Risk
    Although often considered a consequence of other risk categories, reputational risk involves the potential loss of public trust or adverse impact on the organization’s reputation due to operational failures or ethical lapses.

Conclusion

Categorizing operational risk allows organizations to implement targeted and effective risk management strategies. By systematically identifying and assessing each category, institutions can better allocate resources, design controls, and ensure greater resilience against potential disruptions or losses.

Related Posts:

OPERATIONAL RISK MANAGEMENT AND INTEGRATED RISK MANAGEMENT: A COMPREHENSIVE OVERVIEW	UNDERSTANDING OPERATIONAL RISK: DEFINITION, SCOPE, AND MANAGEMENT	CLASSIFICATION OF OPERATIONAL RISK
OPERATIONAL RISK CLASSIFICATION BY EVENT TYPE	OPERATIONAL RISK MANAGEMENT (ORM): DEFINITIONS AND KEY PRACTICES	ORGANIZATIONAL STRUCTURE AND MANAGEMENT: DEFINITIONS AND OVERVIEW
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Operational Risk Articles related to Model ‘D’ of CAIIB –Elective paper:

UNDERSTANDING OPERATIONAL RISK: DEVELOPMENTS, FRAMEWORKS, AND STRATEGIC APPROACHES	CLASSIFICATION OF OPERATIONAL RISK	OPERATIONAL RISK LOSS DATA: A PRACTICAL GUIDE TO COLLECTION, STANDARDS, AND ROOT-CAUSE ANALYSIS
OPERATIONAL RISK IN PRACTICE: RCSA AND KRIS DONE RIGHT	TECHNOLOGY RISK AND INFORMATION SECURITY: PRINCIPLES, GOVERNANCE, AND PROTECTION	ISO 27001-ALIGNED TECHNOLOGY RISK PRACTICES: FROM PATCHING TO DDOS DEFENSE
INFORMATION SECURITY, CYBERSECURITY, AND TECHNOLOGY RISK MANAGEMENT IN MODERN BANKING	CORPORATE GOVERNANCE IN BANKING: PRINCIPLES, PRACTICES, AND GLOBAL BENCHMARKS	RISK GOVERNANCE FOR CLIMATE RESILIENCE AND GREEN FINANCE IN BANKING