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What Is Operational Risk Management (ORM)?
Operational Risk Management (ORM) is the process of planning and implementing techniques to identify, control, mitigate, avoid, and prevent risks associated with a company’s operations. This function is important because operational risks exist in every business. It comprises the management of several potential issues that affect business operations and revenue.
Operational risks refer to risks that arise from failures, problems, or errors in internal systems, processes, or structures. They may also arise from conflicts between people. Even external factors may disrupt the flow of business operations. These risks bring financial losses and a bad corporate or market reputation. Monitoring these risks and taking corrective measures is crucial to an organization’s success.
Table of Contents
- Operational Risk Management refers to identifying, controlling, and mitigating operational risks to streamline day-to-day business operations.
- The ORM process involves the identification, assessment, mitigation, control implementation, and monitoring of an organization’s defined risk management framework.
- ORM is a subset of Enterprise Risk Management (ERM). It contributes to the effectiveness and success of ERM. The ERM structure has a wider scope and allows for more detailed visibility than the ORM.
- Companies face several risks, both due to internal and external factors. ORM helps companies manage them, facilitating operational success and business growth.
Operational Risk Management Explained
Operational Risk Management is a mechanism employed to identify, control, manage, and monitor operational risks that adversely impact day-to-day operations by causing disruptions, excessive expenditure, heavy employee attrition, process and system failures, and other problems. Such risks result in revenue losses, in addition to a loss of reputation, impacting brand image and customer loyalty.
ORM is a subset of the broader concept of Enterprise Risk Management (ERM). Hence, it focuses only on daily business operations and allows companies to tackle these risks and reduce the resultant negative outcomes.
In every business, whether it is a product- or service-based company, risks arise from time to time. ORM promotes risk aversion in business, which allows companies to predict problems and prepare to deal with them. More importantly, it focuses on preventing problems altogether.
This function is not limited to a particular sector or industry since businesses of all sizes and nature need to deal with operational risks. For instance, operational risk management in banks involves following specific guidelines for banking compliance, including legal, operational, digital, cybersecurity, and structural matters (organization design, internal controls, etc.).
Without ORM, companies will be forced to face multiple risks across each function. Even if its internal processes are strong, external factors and the environment (taxation, legal, political, world economy, etc.) can affect daily operations. Hence, uncertainty typically prevails at all times in business.
To avoid financial, revenue, and reputational losses, companies must have an operational risk management framework in place. Furthermore, an operational risk management dashboard enables executives to analyze risks, evaluate incidents, check compliance, track performance, and facilitate reporting, among other things.
It is also vital to understand that promoting a culture of risk management, accountability, and continuous improvement is as important as planning and implementing risk management protocols and controls. Unless processes, systems, and people operate in alignment, no risk management is possible in an organization.
Process Steps
This is a key function and involves multiple steps. Let us study them in this section.
- Risk Identification: Identifying potential risks and threats that can cost the company or jeopardize its operations is crucial. All risks that hamper a company's ability to meet its objectives must be considered. Companies face several risks, such as process and system failures, data theft and confidentiality issues, compliance problems, legal hassles, production issues, IT-related problems, human resources problems, and so on. The external environment, which comprises changing laws, policy decisions, economic cycles, etc., may introduce issues, too.
- Risk Assessment: Every risk a company identifies must be assessed. Based on its threat level and probability, a company must initiate its management. Known risks can be tackled on a regular basis, and a contingency plan helps deal with all other potential risks. Companies can categorize risks per their priority as high, medium, and low and tackle them accordingly, with high-priority items receiving the maximum attention. Additionally, internal audits enable companies to resolve problems from time to time.
- Risk Mitigation: Controlling risks is critical to success. Typically, risks can be handled by transferring, avoiding, accepting, and mitigating them. Through a risk transfer, the losses arising from potential risks are handled by insurance companies or other third-party agencies. Avoiding risks involves taking steps to avoid high-risk situations. Accepting risks means finding ways to address them. Risk mitigation involves improving internal controls, training people to help them take appropriate actions, introducing new technology, improving processes, etc.
- Controls Implementation: Actions are taken, tools are employed, and strategies are implemented at this stage. Policies, procedures, and protocols play a key role at this stage. Clear communication and structured reporting guidelines ensure controls remain active and effective.
- Monitoring: Even though risk management protocols are implemented, companies must monitor the results, changes, and updates to modify plans (as and when needed). This also helps identify any new risks that may arise as internal and external changes take place. Monitoring helps companies proactively handle issues to stay relevant.
Examples
After studying the ORM scope, importance, and process, let us look at the following examples to delve further into the topic.
Example #1
Suppose a logistics company, SwiftMoves Co., known for its on-time delivery and tech support, employs trucks to deliver customer packages on a day-to-day basis. Due to bad weather, a particular stretch of the road was blocked one day. All delivery tasks were stalled, and logistics operations were delayed.
The company’s operations manager, Stacy, had anticipated these risks when she built an operational risk management framework for the company. For all high-value products that could ruin the company’s reputation and its relations with the clients if deliveries were delayed, SwiftMoves Co. had decided to keep a fleet of helicopters ready. Stacy segregated the orders that could not be delayed and ensured that they reached the customers on time.
It is essential to note that Stacy did not treat all orders as high-priority. By doing this, she strategically deployed funds only for those orders that could directly and significantly impact revenue. In this way, Stacy prevented revenue and reputation loss and handled operational problems caused by external circumstances.
Example #2
According to a March 2024 news report, LogicGate, a US-based Governance, Risk, and Compliance (GRC) solutions provider, launched new products - Cyber Risk Suite and Operational Risk Suite - to improve risk management practices across industries.
The company aims to offer integrated solutions to ensure effective enterprise risk management in addition to ORM. These new products are expected to enhance an organization’s capabilities, strengthening both risk management and compliance.
Matt Kunkel, the co-founder and CEO of LogicGate, expressed his views on the importance of offering such modern solutions, considering the varied issues of talent retention, budget consolidations, changing policies, and new threats that companies face. He also said these new suites will help clients generate meaningful insights for effective operational risk management.
Benefits
Given the role ORM plays in ensuring effectiveness, efficiency, and productivity across organizations, we know that its benefits are diverse. Let us study them in this section.
- Through an ORM framework, companies can anticipate risks and prepare early to avert or prevent them by implementing relevant controls.
- Companies can avoid, mitigate, and reduce the adverse impact of risks through internal controls and effective governance per a well-planned ORM approach.
- It promotes sound decision-making, especially with reference to processes and systems.
- Companies can lower their compliance costs by implementing strong and reliable ORM protocols for each function.
- This approach facilitates continuous monitoring of systems, processes, and tools for operational purposes, strengthens risk detection, and addresses vulnerabilities.
- When risks are averted early, operational performance and accuracy improve.
Operational Risk Management vs Enterprise Risk Management
As stated, ORM is a subset of Enterprise Risk Management (ERM). Hence, they differ in many ways, particularly in their implementation approach and methodology. Here are the differences between them.
| Basis | Operational Risk Management | Enterprise Risk Management |
|---|---|---|
| Scope | It focuses on day-to-day business operations, covering internal processes, activities, and tasks, among other things. | Enterprise Risk Management (ERM) is a comprehensive framework that covers strategic, financial, compliance, operational, and other business risks. |
| Goal | The goal here is to ensure smooth daily operations through risk identification and mitigation. | The goal here is to ensure effective risk management at the enterprise level, which facilitates the smooth functioning of the entire organization. |
| Extent of control | ORM is a subset of Enterprise Risk Management (ERM). Hence, it is a contributing factor to an organization’s ERM framework. | ERM takes an exhaustive approach with the intention to achieve overall stability, scalability, and performance. |
| Example | If a bank implements processes and protocols to detect fraudulent transactions, it means the bank has taken a step in the direction of ORM. | If a bank undertakes a comprehensive risk assessment focusing on markets, credit, liquidity, banking operations, cybersecurity, regulatory compliance, statutory banking guidelines compliance, and more, it means the bank has taken a step toward establishing an ERM framework. |
Frequently Asked Questions (FAQs)
The key aspects an organization must consider when developing an ORM framework are aligning the structure with business objectives, identifying risks and vulnerabilities and the means to handle them, setting up a system for data-driven decision-making, and continuous monitoring to ensure effective control. While these points offer a general overview, organizations may need to undertake specific tasks based on the nature of their business.
The challenges companies are likely to face while implementing operational risk management plans include a lack of resources, an inability to identify risks before it is too late, compliance shortfalls, ineffective internal processes, change management hurdles, and system delays, among others.
Traditional risk management involves a reactive approach, where a company addresses problems as and when they arise. Risk avoidance is a major focus area. Modern operational risk management takes a proactive approach, with companies predicting potential risks and taking measures to prevent them. Also, technology has a monumental role to play in modern ORM frameworks.
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