Operational risk refers to the risk of loss resulting from inadequate or failed internal processes, people, systems, or external events. To effectively manage and mitigate such risks, organizations—particularly in the financial sector—commonly classify operational risk events by event type. This classification framework, widely adopted and promoted by the Basel Committee on Banking Supervision, helps institutions systematically identify, assess, and manage various sources of operational risk.
Classification of Operational Risk Events
Operational risk events are generally categorized into the following seven major types:
1. Internal Fraud
Losses arising from acts of a fraudulent nature committed by employees or other internal parties.
Examples:
- Theft and embezzlement
- Bribery
- Intentional misreporting of financial or operational data
2. External Fraud
Losses resulting from fraudulent acts perpetrated by external parties, including customers, vendors, or other third parties.
Examples:
- Forgery and cheque fraud
- Cyberattacks and hacking incidents
- Robbery and other forms of physical theft
3. Employment Practices and Workplace Safety
Risks associated with employee relations, workplace conduct, and adherence to health and safety standards.
Examples:
- Discrimination and harassment claims
- Violations of labor laws and regulations
- Workplace injuries or safety breaches
4. Clients, Products, and Business Practices
Risks arising from a failure to meet client obligations, poor product design, or improper business conduct.
Examples:
- Mis-selling of financial products
- Inadequate disclosure of product risks
- Breach of fiduciary or professional duty
5. Damage to Physical Assets
Losses due to the destruction or impairment of physical property or infrastructure.
Examples:
- Natural disasters (e.g., earthquakes, floods)
- Acts of vandalism or terrorism
- Accidents damaging equipment, buildings, or inventory
6. Business Disruption and System Failures
Risks resulting from interruptions to business operations or failures in IT systems and infrastructure.
Examples:
- Power outages and telecommunications failures
- Software or hardware malfunctions
- Disruptions in supply chain or critical service providers
7. Execution, Delivery, and Process Management
Risks arising from failed transaction processing, inadequate process controls, or operational delays.
Examples:
- Errors in trade execution or settlement
- Data entry or reporting mistakes
- Failures in process design or oversight
Conclusion
These seven event-type classifications serve as a standardized framework for operational risk management across the financial industry. By categorizing risk events, organizations can more effectively track, analyze, and mitigate operational risk exposures. Furthermore, many institutions develop more granular sub-categories within these broad classifications to address specific operational challenges aligned with their unique risk profiles and business models.
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