Definition of Business Risk
5 Operational Risk Examples
John Spacey, July 25, 2015 updated on March 24, 2021
Operational risk is the probability of a loss due to the day-to-day operations of an organization. Every endeavor entails some risk, even processes that are highly optimized will generate risks. Operational risk can also result from a break down of processes or the management of exceptions that aren't handled by standard processes. The following are a few examples of operational risk.
1. Human ErrorA mechanic leaves a tool inside an jet engine resulting in the blowout of the engine during flight. The aircraft is able to return to the airport but the passengers are shaken, the airline's reputation is damaged, they face a government investigation and the engine must be completely replaced.
2. Information TechnologyA critical network device experiences an error that results in a 4 hour outage for the website of an online retailer. Revenue is lost and customer satisfaction declines for the month.
3. Insufficient ProcessesThe settlement process for an investment bank is only designed for regular market volume. One day there is a market crash and volume on the stock exchanges spikes to 50x normal. The settlement process fails because it involves manual steps and the bank doesn't have enough trained staff to complete the processes in a timely fashion. Customers are impacted as their orders don't show as settled within the regular time. The bank suffers a loss of reputation with its customers and trading counterparties.
4. Process FailureA customer service process breaks down due to a lack of training. A number of customers who were entitled to refunds according to local regulations are mistakenly told they do not qualify. The customers complain to regulators who launch an investigation of the company. The company faces fines and negative publicity.
5. Quality RiskAn electronics company establishes a quality assurance process that catches 99.99% of defects in their vacuum cleaners. They therefore expect that 0.01% of their products with have a minor defect and they establish a return policy that allows customers to get a replacement product should they discover a problem. The company budgets for such returns in their cost forecasts.
NotesIt should be noted that some definitions of operational risk suggest that it's the result of insufficient or failed processes. However, risk can also result from processes that are deemed sufficient and successful. In a practical sense, organizations choose to take on a certain amount of risk with every process they establish.
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