Question

Explain operational risks and give two examples of such risks faced by management at financial institutions

Answer 1

Introduction to operational Risk: Operational risks summarizes the uncertainties and hazardous a company faces when it attempts to do its day to day business activities. It is the risk of a change in value caused by the fact that actual losses, incurred for inadequate or failed internal processes, people's and systems, or from an external events including a legal risk, differ from the expected losses. These are usually not willingly incurred nor are they revenue driven. Moreover, they are not divesifiable and cannot be laid off.

Examples of operational Risks faced by financial institutions:

(1) Cyber security Risks: Even as financial institutions ramp up their cybersecurity efforts, cyber risks, including ransomeware and phishing, have become more frequent and more effective, posing a major risk to financial institutions.

(2) Third-party risks : Increasingly, financial institutions are relying on third-party providers, which means they have to thoroughly identify, evaluate, and control the third-party risks throughout the entire life cycle of their relationships with those companies. However, financial institutions also have to identify and evaluate the risks associated with the vendors, suppliers and the contractors.

(3) Internal fraud: Losses from fraud inside a financial institution can stem from misappropriation of assets, forgery, tax non-compliance, bribery and theft.