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Top 5 Operational Risks Every Financial Institution Should Be Aware of

Top 5 Operational Risks Every Financial Institution Should Be Aware of

Operational risks account for a fairly significant portion of an average company’s risk management landscape but the equation changes rather dramatically when it comes to the financial sector. Banks, credit unions, lenders, and others in the financial space must confront a great deal of operational risk simply due to the very nature of their business model. What’s more, the financial sector is a prime target amongst cyber criminals and other bad actors, which means that the sheer number of risks is much greater than what you may see in another less-targeted industry.

Operational risk — that is, risk arising from failures associated with people, processes, external events, and systems — can be especially challenging from a risk management and mitigation perspective because many risk factors and vulnerabilities can never be fully eliminated. You may have multiple threats that can only ever be partially neutralized, along with vulnerabilities that are inherent to a particular way of doing business. 

This leaves many business leaders and stakeholders within a financial institution wondering about the best way to mitigate and manage operational risks. While there are lots of different risk management strategies to consider, many find success through education and collecting knowledge on the dynamics of the most significant and serious risk factors. Let’s explore the top five operational risks every financial institution should be aware of as they develop or refine their risk management strategy. 

#1 – Financial Institution Operational Risk from Bad Actors Within the Company

While a majority of bank employees are good, honest, hard-working people, it only takes one bad actor to cause huge amounts of damage from a risk management perspective. Banks — and companies of all kinds, really — face a slippery slope when it comes to screening and investigating employees. Nobody likes to feel as though they’re suspect, especially when they’re innocent of any wrongdoing. But practically speaking, it would be negligent for a financial institution to ignore the risk that’s associated with its employees and their actions. 

Background checks are now regarded as a standard and well-accepted component of the hiring process across all industries and business sectors. But continual reputation monitoring is still not standard practice. Yet for some industries like the banking sector, continual monitoring is really important if you’re going to minimize risks and feel confident about bank staff integrity. 

The reality is that life circumstances change and this can change an individual’s behavior. Someone who may have had a clear criminal record at the time of hiring could later find themselves in a tough financial situation that prompts them to act in a dishonest way. This poses a serious threat from a risk management perspective and it’s something that a bank must address in their risk mitigation efforts.

Some risk management software platforms include modules designed to perform background checks, reputation evaluations, and personnel screening. These platforms feature integrations with a variety of different background check resources, public records, credit bureaus, and other key data sources. As a whole, the data is gathered and collectively evaluated to arrive at a threat assessment. The individual in question gets a score or rating that represents their threat level.

These risk management software systems also include monitoring capabilities. Key data sources such as criminal records are periodically checked and an alert is sent out if a significant change is detected. This provides bank leadership with an opportunity to monitor the situation in a more proactive manner. But more importantly, it positions bank leaders to provide support whenever possible.

This says nothing of the bad actors who actively seek to get hired at a bank in order to get into a better position to commit a crime. Background checks and screening can identify a segment of these individuals during the hiring process, but someone will inevitably slip through the cracks. This underscores the importance of taking a proactive stance toward risk management as a whole. 

#2 – Operational Risk from Poor Third-Party Risk Management (TPRM)

Third parties such as vendors and contractors can pose a tremendous risk to a financial institution because these channels serve as a relatively easy mechanism for gaining access “behind the scenes.” Why hack into a computer system when you can simply walk in as a contractor who is granted access by the bank’s IT team? And no need to break out the bank’s windows to gain after-hours access. You only need to join the bank’s cleaning team and you’ll be provided with a key and access to all regions of the building. 

Third-party risk management (also known as TPRM) is an important part of any financial institution’s operational risk management strategy. A well-built third-party risk management software platform will provide the tools you need to evaluate contractors, vendors, and other third parties who do business with your financial institution. These TPRM software systems are integrated with a variety of resources, including background check systems, credit scores, public records, and reputation evaluation tools. Collectively, this information is evaluated to arrive at a metric that represents an individual’s threat level. This information can be used to make informed decisions on what access an individual receives and which vendors or contractors you opt to engage. 

#3 – Operational Risk from Human Error

Banks see a fair amount of operational risk arising from human error. While dispensing cash, a bank teller can easily mis-count bills or a couple of fresh bills could easily stick together. A small distraction or simple typo could cause an employee to enter the wrong number into a spreadsheet, resulting in challenges downstream. Human error takes many forms and it’s unavoidable as long as humans are involved in a workflow or process. 

Financial institutions do enjoy one benefit in the area of human error and risk management: the formulaic, math-based nature of this work means that a large segment of human error can be discovered with relative ease. The numbers simply won’t add up and this is a clear indication of an error. This is far easier to detect — and thus, address — than an error such as an inaccurate fact in a report. 

Establishing standard workflows and processes is one method for minimizing human error, since we tend to be more consistent when there is an established, repeatable series of steps that ought to be followed. Process automation also offers an opportunity to reduce the incidence of human error and the risk that accompanies these errors. Process automation allows you to streamline and optimize workflows and processes too, allowing for greater efficiency. Automation can effectively mitigate virtually all risks associated with process-related human error, making this an easy win in a bank’s risk management quest. 

#4 – Legal and Regulatory Compliance Risk Management 

Legal and regulatory compliance risk management is a serious concern for financial institutions due to the highly-regulated nature of this business space. Banks are subject to countless laws and regulations that profoundly impact the ways in which they do business. This is one area of vulnerability that affects virtually every aspect of a financial institution’s operations, from record-keeping and data management practices to cybersecurity measures and even the mobile apps that bank employees use to communicate with clients. 

The impact of regulatory non-compliance cannot be underestimated. Take the case of nearly a dozen major banks that were collectively fined $1.8 billion dollars after it was found that bank employees were using WhatsApp, Signal, and iMessage to communicate with clients. This led to record-keeping violations and fines totaling hundreds of millions of dollars per bank. 

Today’s best risk management software platforms include regulatory compliance tools that are designed to help banks identify regulatory burdens, pinpoint areas of non-compliance and plan out a response for achieving and maintaining compliance. Operational risk management strategies should also address processes and workflows as they relate to regulatory compliance. By implementing standard, compliant protocols, procedures, and processes, you can be confident that your bank is operating in a compliance-friendly manner, thereby reducing risk levels. 

#5 – External Events and Operational Risk Management

External events hold the potential to impact a bank’s operations in some profound ways. Money markets, interest rate changes coming down from the Federal Reserve, and broader economic events routinely affect financial institutions both large and small. 

Unfortunately, there’s no way to really influence or control most of these external events. This is especially true of large-scale events. But you can prepare. Take the time to form a risk management task force, composed of stakeholders and leaders from all departments and divisions. This diversity is important because you need insights from a broad variety of perspectives in order to be effective in your risk mitigation efforts. This task force will meet periodically to develop a proactive strategy, in addition to response protocols and processes. This is also an opportunity to take proactive measures that position your financial institution to emerge from a bad situation unscathed. By having a set process in place to deal with an event, you can minimize the damage. 

Risk Management Software to Combat the Top 5 Operational Risks Every Financial Institution Should Be Aware Of

The right technology will go a long way toward forwarding your bank’s risk mitigation efforts. Third-party risk management (TPRM) software helps you deal with vendors, contractors, and other external parties who may pose a risk to your financial institution, while risk management software platforms will have tools for managing and mitigating the other forms of operational risk, arising from employees, human error, regulatory compliance and beyond. 

At iTech, we specialize in providing financial institutions with the technology they need to achieve their operational risk management goals. Contact the iTech team today and let’s begin a dialogue on your operational risk mitigation needs.