What is Operational Risk in Financial Institutions and Banks?

Banks and financial institutions have a broad and rather complex risk management landscape, with operational risk accounting for a fairly sizable portion of the risk equation. But what is operational risk in a bank, credit union, or other financial services provider? How do these companies manage operational risk in a manner that allows for maximum profitability and long-term success?

The Definition of Operational Risk in Financial Institutions and Banks

Operational risk refers to the risks and vulnerabilities that arise as a result of failures, flaws, or insufficiencies that involve some aspect of a company’s operations. These failures may be related to a bank’s processes, policies, procedures, employees, systems, external events, and technologies. 

Operational risk in financial institutions and banks may also involve the institution’s level of compliance — or lack thereof — with regulatory requirements and laws. For example, if a bank were to allow its employees to use a consumer-grade messaging app for communications with clients, they may violate record-keeping laws that call for the preservation of messaging data between bank employees and clients. In fact, this is precisely what occurred with nearly a dozen major banks. The Securities Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) handed down nearly $2 billion dollars in fines to the banks. This could be considered an operational risk since it was an operational decision that created the conditions that ultimately led to non-compliance and record-keeping law violations. 

Notably, operational risk stands apart from other aspects of the risk management landscape, such as reputational risk and strategic risk. 

How to Manage Operational Risk in Financial Institutions and Banks?

There are countless conditions that translate into operational risk in financial institutions and banks. Effective operational risk management is essential for long-term success, yet the diverse and all-encompassing nature of these vulnerabilities demands a complex mitigation strategy. 

An efficient risk management strategy begins with the identification of existing and prospective operational risk factors or vulnerabilities. Once these threats and vulnerabilities have been pinpointed, you must evaluate severity, developing a priority level for each risk. This prioritization process is important because you’ll need to determine which issues need to be addressed immediately and which issues can be addressed down the road.

With operational risk factors identified and prioritized, the bank must develop a mitigation plan for addressing each issue. Risk mitigation strategies require a fair amount of oversight in order to ensure success, which is where you can benefit from the project management-type tools that are found within the best risk management software platforms. These platforms give you the ability to outline the steps that are required to resolve an issue. Then. you can assign those tasks to the appropriate individual, with each collaborator having the ability to post updates as the tasks are completed. These platforms allow for project tracking and collaboration which is essential for successful risk mitigation. 

Not every operational risk factor can be identified and predicted in advance, but a large portion can be effectively mitigated if you have the right insights. This underscores the importance of working with leaders from throughout the company’s various departments and divisions as you work to develop an operational risk management strategy. Leaders and supervisors who are immersed in the day-to-day operations of their department or division will have unique insights that may be elusive to those who work in other areas of the company. This information can be critical for the development of a complete operational risk management plan so it is essential that you pull these leaders into the fold as you strategize. This approach ensures that you have all of the information required to effectively identify risk factors. These business leaders will also be helpful in evaluating the effectiveness of your mitigation efforts. 

The Role of Software for Operational Risk Management in a Bank Setting

Risk management software offers a helpful toolset that can be used to identify and mitigate operational risk in financial institutions and banks. These software platforms feature tools that can be used to identify and evaluate risk factors, threats, and vulnerabilities that a bank may be confronting. Once an issue is identified, its severity can be evaluated. With this information in hand, business leaders can effectively prioritize their risk mitigation efforts. The best risk management software platforms also feature project management-type tools that are used to plan and track the progress of mitigation-related tasks. 

With such intense regulatory oversight, banks can also benefit from risk management software platforms that feature a regulatory compliance dashboard. These software systems provide updates on new regulatory requirements and changes to existing regulations. The banking industry is very heavily regulated and keeping track of new laws and regulations can be very challenging. By providing business leaders with updates on regulatory compliance-related issues, they are better positioned to avoid non-compliance and the related operational risks that may exist. 

Finding the right risk management software solution to identify, monitor, and mitigate operational risk in financial institutions and banks can be challenging. Yet this technology is really essential for success when you consider the complex and high-stakes nature of the banking industry’s risk management profile. Many banks find that out-of-the-box solutions simply don’t meet their needs. This is where a custom digital transformation project can be very beneficial, as the bank works with a development company to create a customized risk management software platform. 

At iTech, we have extensive experience in the development of risk management software. Our innovative developers also specialize in regulatory compliance software platforms. This broad range of expertise allows us to create enterprise software solutions that empower banks and others within the financial space to effectively manage and mitigate operational risks.

 iTech’s team will collaborate with the client, gaining an in-depth understanding of their operations, challenges, goals, and priorities. Then, we’ll architect a digital transformation solution with the tools and features that the organization needs to succeed. Contact the iTech team today to begin the discussion about your company’s risk management strategy.