Operational Risk

🔹 Definition

Operational Risk refers to the risk of loss resulting from inadequate or failed internal processes, people, systems, or from external events. Unlike credit or market risk, operational risk stems from the execution of day-to-day business operations, and it includes risks such as fraud, human error, cyberattacks, system failures, legal breaches, and third-party disruptions.

The Basel Committee on Banking Supervision identifies operational risk as one of the core risk categories that financial institutions must assess and manage, especially in relation to AML/CFT compliance, data governance, and digital infrastructure.

🔹 Frequently Asked Questions (FAQs)

Q1: What are examples of operational risk?

• Internal fraud: Employee misconduct, data tampering
• External fraud: Phishing, ransomware, payment fraud
• System failure: IT outages, software bugs, API errors
• Process breakdowns: Incomplete due diligence, failed compliance checks
• Third-party/vendor issues: Failure of outsourced KYC providers or cloud platforms
• Legal or regulatory breaches: Non-compliance with reporting obligations
• Natural or geopolitical events: Earthquakes, pandemics, political unrest

Q2: How does operational risk differ from other risk types?

• Credit risk: Arises from borrower default
• Market risk: Linked to price or rate movements (e.g., FX, interest rates)
• Operational risk: Involves failures in internal controls, human error, or external disruptions

Q3: Why is operational risk important in AML/CFT programs?

• Poor internal systems may lead to missed suspicious activity reports (SARs/STRs)
• Untrained staff can overlook risk indicators or KYC red flags
• Inadequate technology controls can expose firms to fraud or regulatory breaches
• Operational weaknesses can result in hefty fines, reputational harm, and loss of license

Q4: How do organizations manage operational risk?

• Establish an Operational Risk Management Framework (ORMF)
• Conduct regular risk assessments and scenario planning
• Monitor Key Risk Indicators (KRIs) and maintain a risk register
• Invest in internal audits, incident response plans, and business continuity planning (BCP)
• Evaluate and monitor outsourced service providers

Q5: Are there regulatory expectations for operational risk?
Yes. Global and local regulators (e.g., Basel Committee, MAS, FCA, ECB) require financial institutions to:

• Identify, assess, and document operational risk exposures
• Integrate operational risk into governance and compliance frameworks
• Maintain capital buffers to absorb operational losses (as per Basel III)
• Implement systems to report material events and remediation actions