Even after a detailed study of risk, risk factors, risk assessment and risk management fundamentals, a very common question that keeps knocking on the brain is “what is operational risk?”
This is because the operational risk is often regarded as the topic to be discussed or focused upon in the end of the priority list.
I have focused this article mainly on “what is operational risk and how to understand it better in order to minimize it.
What is operational risk
If I try to define the operational risk in the simplest words, I would state that it is the risk of change in the pre-calculated risk value because of the actual losses that occur because of the improper or outperforming internal work processes, human resources or support systems or because of uncertain external factors.
The operational risk is the risk apart from the expected or calculated losses from known hazards.
Why operational risk is more risky
This is so because, firstly, operational risk is unforeseen and non-predicted risk. Its value cannot be approximately anticipated because you cannot be sure how actually efficient your people, processes and systems will be, when put to the real operation. Secondly, operational risk cannot be fully avoided or eliminated by any of the risk management tools. This is so because; you cannot expect the people, processes or systems to be 100 percent perfect in their operations. The risk of losses due to this operational inefficiency is not a willing risk and thus you cannot totally get rid of it. Thirdly, the external factors (globalization, diversification, changing organizational behavior management, penetration of digital and virtual media, hard money etc.) Are on the trending curve, and are contributing to the operational risk, the operational risk management becomes all the more crucial and competitive edge.
How to do operational risk management?
Now that you have got a clear idea of what operational risk is, and what is the effective scope area of this risk, the next thing you might be searching answers to, will be how to manage this risk?
Well to bring an answer to this important query, I would like to give a brief introduction to various methods for operational risk management.
Before adopting any method of operational risk management, you must focus on developing an effective framework for it. The framework must include:
Identify-> measure-> monitor-> report-> control-> mitigate.
Identify the inefficient factors to be it people, process or any system.
Make a qualitative and quantitative calculation for the inefficiency of that factor.
Monitor the operational risk for a significant time period and report it to the authorities accountable.
Develop feasible and self-specific controlling tools for the overcoming the inefficient operational units.
Implement the tools to mitigate the operational risk.
The above framework must be followed in the same order in a closed process manner without leaving behind any loopholes before moving on to the next step of the process.
When you approach certain projects or plans with a professional and profit oriented thought process, risk assessment becomes an important aspect of the process.
The thorough knowledge of risk assessment and risk assessment tools is a must in an environment where no business, institution or domain is completely cushioned against numerous probable risks.
In this article, I have tried to club up the central idea of my detailed study about the various risk-assessment methods and the best practiced risk assessment tools.
What is risk assessment?
You cannot grasp the idea or successfully implement the risk assessment tools until you are briefly introduced to the concept of risk assessment.
If I put it in very simple words, risk assessment can be defined as calculation or measurement of the value of risk associated with a certain situation and a known and anticipated hazard. The measurement of the value of risk can be either of a quantitative or qualitative form.
There are various ways in which one can reach to this value of risk. These ways are called risk assessment tools which differ with subject to their applicability.
What are the most successfully used risk assessment tools?
When we talk about the most successfully implemented risk assessment tools, we confine our statement with subject to the area or domain of their usage. Certain risk assessment tool can be very successful in a specific situation, but can be a complete irrelevant one in another situation.
Here I enlist the various risk assessment tools which find a very wide application in various risk assessment studies.
All these kinds of tools have their applications in various fields of operation. These tools are developed by high end agencies (osha, EPA, WHO etc.) to guide individuals, enterprises and communities to support their risk assessment process.
Not all the tools are of generic form, they differ from sector to sector based upon the sector specific requirement.
Risk assessment tools in various sectors
Nowadays, the software based applications are the most trending and efficient risk assessment tools and they are finding their application in almost all the sectors you can name at random.
- WHO human health risk assessment tool
- Debtors risk assessment tool
- Falls risk assessment tool for health sector
- Accident prevention risk assessment tool for construction sector.
- Checklist tool for manufacturing companies.
- Higher education risk assessment tool
- Enterprise Risk Management (ERM)
The list goes endless. You can find (from online software directories) a suitable tool for your organization or project if you have already prepared a list of all your probable risks.
If have not enlisted your risks yet, then you must go through risk or hazard identification tool, risk ranking tool before proceeding to advanced risk assessment tools.
The trends show that more of the people are inclined towards using quantitative assessment of risk. My take on this trend is that qualitative value of risk assessment is equally important if you want to stand proactively one step ahead of even the hidden risks.
When you talk about risk on professional levels, you always tend to implicate varied risk control and risk management tools to mitigate various kinds of risks specific to your sector.
But there are certain risks which cannot be cooped up with, because of various factors. This is where the third party involvement comes into the picture of risk management. Clearing houses are one of those third party institutions which work as risk managers for their clients.
What are clearing houses?
Before understanding the clearing houses, you need to go through a certain background conditions where they work, as this will develop a better understanding of the clearing house.
When there are significant transactions between two parties, and the transactions are executed in the future or securities exchange or in the OTC (over the counter) market; there develops a need for a reliable intermediary which can assure the risk involved in these types of transactions.
The clearinghouse is that intermediary and the two parties among which the transaction takes place are called member firms.
Clearinghouse works as an outsourced partner with an aim to mitigate the risk of one side of the member firms to safeguard its financial transaction obligations.
How does the clearing house work?
When any trade transaction is completed between the two member firms, the trade responsibility can be outsourced to the clearing house, making it the legal party for handling risk of that particular trade.
NOVATION: The concept of transferring the trade and its involved risks to the clearing house is known as innovation.
A clearing house itself is a well organized and proactively funded organization to shoulder the risk of its clients even in the cases of failure of risk mitigation instances. The clearing house a strong work frames for the defaulter member firms and has the power to uphold the liquidation profits of the defaulter member firm or the guarantee fund for making settlements amongst the member firms.
The bilateral trade agreements involve the risk factor of any of the partners to play as a defaulter, the risk of which its counterpart cannot afford or stand. This risk of the counter party to go defaulter is called counterparty risk.
Thus the work of the clearing house is to play as an intermediate counterpart which has the expertise, responsibility and resources to fulfill any kind of counterparty risks.
What are the services provided by the clearing house?
The clearing house works as a platform with a dedicated bundle of services required by the parties involved in bilateral trade.
The responsibilities undertaken by the clearing house, when working as a third counterpart in any bilateral trade are:
To monitor the markets
To monitor the margins
To make requirements for the margins
To execute margin checks
To execute margin calls
To tabulate market to market calculations
To execute the risk checks
To clear the outstanding balances in the bilateral trade
To undergo and account for the final settlement between the member firms.
We rely on various advices from both online and offline sources to get to know the best risk management strategies, but still we see ourselves wandering through the doubts of numerous typical financial or management terms. Here I have tried to club all the basic information about the risk mitigation and risk mitigation strategies in a manner that can be easily understood, implemented and monitored upon.
Why is risk mitigation important?
Being an active mind in any business plan or personal investment plan, is not that easy after all. The most focused yet often half-informed part of any investment plan is the risk and risk mitigation or a good risk management.. Risk mitigation is important because without a proactive plan, one may fall trap to certain hidden risks involved in the projects
What are risk mitigation?
If we go through the most basic definition of risk mitigation, we can say that it is a planned process of various steps in order to reduce the impact of any unwanted circumstances i.e. to lower the adverse effects on any significant plan or project.
If you do not calculate and take proactive steps for the risk factors that can affect any of your plans, then you dig a loss hole for yourself with your own hands. Therefore, risk mitigation is equally important and an inseparable part of the project plan.
Here in this article, I shall discuss various Risk Mitigation Strategies. After getting the basic and well-informed idea of all the strategies, you have to work out on the decision that which strategy suits your project/plan requirement in the best way.
What are various Risk Mitigation Strategies?
The risk mitigation plan or strategies can be broadly classified into four types. You may have to study your project plan and see which strategy best suits to your specific needs and capacity.
The various risk mitigation techniques are:
Accept it: This is technically termed as Risk Acceptance Strategy. This is the most common alternative adopted by people. This strategy is not capable of reducing any negative effects of risk, but is adopted when you have limited resources to afford the other strategies. I suggest this strategy if the foreseen risks are not in very significant effect and have less than 50% possibility of occurrence or if the net costing of other mitigation options calculated in an amount more than the loss possibility in case of the risk.
Avoid it: This strategy suits to the plains where risk acceptance does not stand as an option because of its high anticipated losses. I suggest this strategy if you foresee huge risk with high probability and if you have resources enough to afford this most expensive strategy for risk mitigation.
Limit it: A well worked upon a mix ratio of both the Risk acceptance and risk avoidance techniques leads you to a good risk limitation strategy. This is suggested for cases where you can neither fully avoid (because of high risk involvement) nor fully accept it (because of resource constraint)
Transfer it: The risk transference strategy involves a willing risk sharing partner. The risk mitigation as a whole can be outsourced on a well charted contract base, to a different business house or business partner which has its expertise in risk mitigation.