4.
Operational Risk
Operational risks refer to the various risks that can arise from a company's ordinary
business activities. The operational risk category includes lawsuits, fraud risk,
personnel problems, and business model risk, which is the risk that a company's
models of marketing and growth plans may prove to be inaccurate or inadequate.
“Operational Risks” is a risk that includes errors because of the system, human
intervention, incorrect data, or because of other technical problems. Every firm or
individual has to deal with such an operational risk in completing any
task/delivery.
The Basel Committee defines the operational risk as the "risk of loss resulting
from inadequate or failed internal processes, people and systems or from
external events".
This definition includes human error, fraud and malice, failures of information
systems, problems related to personnel management, commercial disputes,
accidents, fires, floods... In other words, its scope seems so wide you do not
immediately perceive the practical application.
Types
1. Internal Fraud – misappropriation of assets, tax evasion,
intentional mismarking of positions, bribery[10]
2. External Fraud – theft of information, hacking damage, third-party theft and
forgery
3. Employment Practices and Workplace Safety – discrimination, workers
compensation, employee health and safety
4. Clients, Products, and Business Practice – market manipulation, antitrust,
improper trade, product defects, fiduciary breaches, account churning
5. Damage to Physical Assets – natural disasters, terrorism, vandalism
6. Business Disruption and Systems Failures – utility disruptions, software
failures, hardware failures
7. Execution, Delivery, and Process Management – data entry errors,
accounting errors, failed mandatory reporting, negligent loss of client assets
Difference between financial risk and commercial risk
Basis for
Commercial Risk Financial Risk
Comparison
Financial risk is the risk of
Business risk is the risk of not being able
not being able to pay off
to make the operations profitable so that
Meaning the debt that the company
the company can meet its expenses
has taken to get financial
easily.
leverage.
What it’s all Financial risk is related to
Business risk is purely operational.
about? the payment of a debt.
Yes. If the firm doesn’t
Avoidable? No. take debt, there would be
no financial risk.
The financial risk would be
The business risk will be there as long as there until the equity
Duration
the company operates. financing is increased
drastically.
To generate better returns
Every business wants to perpetuate and and to tap into the lure of
Why? expand, and with continuation comes the financial leverage, the
risk of not being able to do it. company gets into debt and
takes the financial risk.
How to handle By systemizing the process of By reducing debt financing
it? production and operation and by and by increasing equity
minimizing the cost of
production/operation. financing;
We can look at the debt-
Measurement When there’s variability in EBIT; asset ratio and financial
leverage multiplier.
