Operational Risk

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What is 'Operational Risk'

Operational risk summarizes the risks a company undertakes when it attempts to operate within a given field or industry. Operational risk is the risk not inherent in financial, systematic or market-wide risk. It is the risk remaining after determining financing and systematic risk, and includes risks resulting from breakdowns in internal procedures, people and systems.

BREAKING DOWN 'Operational Risk'

Operational risk can be summarized as human risk; it is the risk of business operations failing due to human error. It changes from industry to industry, and is an important consideration to make when looking at potential investment decisions. Industries with lower human interaction are likely to have lower operational risk.

Focus of Operational Risk

Operational risk focuses on how things are accomplished within an organization and not necessarily what is produced or inherent within an industry. These risks are often associated with active decisions relating to how the organization functions and what it prioritizes. While the risks are not guaranteed to result in failure, lower production or higher overall costs, they are seen as higher or lower depending on various internal management decisions.

Examples of Operational Risk

One area that may involve operational risk is the maintenance of necessary systems and equipment. If two maintenance activities are required, but it is determined only one can be afforded at the time, making the choice to perform one over the other alters the operational risk depending on which system is left in disrepair. If a system fails, the negative impact is associated directly with the operational risk.

Other areas that qualify as operational risk tend to involve the human element within the organization. If a sales-oriented business chooses to maintain a subpar sales staff, due to its lower salary costs or any other factor, this is considered an operational risk. The same can be said for failing to properly staff to avoid certain risks. In manufacturing, choosing not to have a qualified mechanic on staff, and having to rely on third parties for that work, can be classified as an operational risk. Not only does this impact a system's operation, it also involves additional time delays as it relates to the third party.

Willing participating in fraudulent activity may also be seen as operational risk. In this case, the risk involves the possibility of repercussions if the activity is uncovered. Since the decision is active, it is considered a risk relating to how the business operates.

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