How do financial institutions manage operational risk?

Let’s face it — banks may look all fancy with their tall buildings and shiny apps, but behind the scenes? It’s chaos if things aren’t managed well. One wrong click, one broken process, or one angry hacker — and boom, things can go south really fast.

That’s where operational risk kicks in.

It’s not the kind of risk that comes from markets crashing or borrowers not paying back. This is the risk that lives right inside the business — hiding in everyday things like processes, people, and systems.

What Is Operational Risk?

Alright, no textbook jargon. Think of operational risk as what happens when things don’t go according to plan.

• A software glitch crashes your payment system.
  
• A staff member makes a wrong entry in an account.
  
• Someone accidentally emails customer data to the wrong person.

In simple words? It’s when people, processes, or technology mess up.

It may sound boring, but trust me — it’s a big deal. Because when it happens in banks, it doesn’t just lead to angry customers… it can mean serious money loss.

Examples of Operational Risk

Let’s bring this to life. Here are a few real (and painful) examples:

• A bank’s mobile app goes down on salary day. Customers can’t access their money.
  
• A staff member mistakenly transfers ₹1 crore instead of ₹1 lakh.
  
• A cyberattack steals lakhs of customers’ confidential information.
  
• A fire in the server room wipes out transaction data.

Scary? Absolutely. But it happens — and often.

Best Practices for Managing Operational Risks

So how do financial institutions stop the madness?

They can’t eliminate all risks, but they can reduce the damage. Here’s how:

• Set strong rules for how everything should be done — and double-check those rules.
  
• Automate where possible. Humans make mistakes. Machines (mostly) don’t.
  
• Train staff regularly so they don’t fumble during crunch time.
  
• Keep backups — and then back those backups.
  
• Test their systems often, like running fire drills for digital disasters.

It’s all about preparation. You don’t wait for the fire to buy a fire extinguisher.

Understanding Operational Risk

Here’s how I explain it to my cousin:

“If you run a business, and something breaks — even if it’s not your fault — you’re still responsible.”

Operational risk comes from:

• People – untrained staff, internal fraud, even honest mistakes.
  
• Processes – unclear steps, no checks and balances.
  
• Technology – system crashes, data loss.
  
• External Events – floods, fire, cyberattacks, or even a pandemic.

It’s like driving a car. The risk isn’t just about other drivers or potholes. It’s also about whether your brakes work, if you’re alert, and if your GPS is reliable.

Causes of Operational Risk

Operational risk isn’t always loud and dramatic. It creeps in quietly. Some common causes:

• Doing things manually instead of automating.
  
• Not updating your systems.
  
• No clear communication.
  
• Weak internal controls.
  
• Not testing systems enough.

It’s not always a villain. Sometimes, it’s just a tired employee clicking the wrong button.

The 7 Categories of Operational Risk

Banks and financial firms usually bucket operational risk into these 7 categories:

1. Internal Fraud – Staff misusing their position for personal gain.
   
2. External Fraud – Outsiders attacking or tricking the system.
   
3. Employment Practices – Workplace issues like harassment or unfair dismissal.
   
4. Clients and Products – Selling the wrong product to the wrong person.
   
5. Damage to Physical Assets – Natural disasters or accidents.
   
6. Business Disruption – Network down, ATM failure, system crash.
   
7. Process Failures – Errors in how things are done.

Each of these needs a different strategy to tackle.

How to Assess Operational Risk

Now that you know what it is, how do banks figure out how bad the risk is?

Here’s what they use:

• RCSA (Risk Control Self-Assessment) – Internal teams check their own risks.
  
• KRIs (Key Risk Indicators) – Early warning signs, like temperature rising before a fever.
  
• Past Incidents – Learn from mistakes, both their own and others’.
  
• Scenario Planning – “What if” exercises to prepare for worst-case events.

Basically, they try to spot the cracks before the building shakes.

How to Manage Operational Risk

Managing operational risk is like personal hygiene — boring, but necessary.

Here’s the playbook:

• Spot the weak spots.
  
• Measure how risky they are.
  
• Monitor them constantly.
  
• Fix or control them — through tech, training, or better processes.
  
• Report any issues without delay.

Some big banks even have a whole Operational Risk Team that does nothing but monitor risks all day.

Operational Risk vs. Other Types of Risk

All risks aren’t the same. Here’s how operational risk stacks up against others:

So yeah, operational risk is more “inside job” than “outside shock.”

FAQ

Q1. How to manage operational risk in banks?

By setting up systems, training staff, using tech, and constantly checking what could go wrong. It’s part detective work, part repair work.

Q2. How do financial institutions manage risks?

They use risk assessments, tools, analytics, and set rules to avoid surprises. It’s all about staying 10 steps ahead.

Q3. What are the methods used to manage operational risk?

Self-assessments, key indicators, past event analysis, and future scenario testing — all rolled into one big control system.

Q4. What are the 5 steps of ORM?

1. Spot the problem
   
2. Judge how bad it is
   
3. Decide how to fix it
   
4. Put the fix in place
   
5. Keep an eye on it

Final Word:

Operational risk isn’t glamorous. There are no stock charts, no big investment decisions. But when it hits, it can wreck everything. That’s why banks treat it seriously — like a silent alarm they always keep an ear out for.

Disclaimer : Investments in debt securities/ municipal debt securities/ securitised debt instruments are subject to risks including delay and/ or default in payment. Read all the offer related documents carefully.