Operational Risk

Operational risk (OR) is the risk that a trading house faces due to a failed internal process or system/network flaw.

 

OR involves a wide range of “non- financial problems” such as:

• Technology risk where a computer system or network architecture is not updated, or there is incompetence in the personnel using them.

• Lack of structured risk policies.

• Process-related risks such as possibility of error in information processing, data transmission, data retrieval and inaccuracy of result or output.

• Other risks include lack of proper monitoring of risk, employee’s or management’s involuntary errors, employee or management frauds or criminal activities.

• Finally, it could include losses due to natural disasters, terrorism and so on.

In a financial institution, the leveraged nature of derivatives transactions makes them susceptible to operational risks such as not accurately valuing the complex derivative products or taking more leverage than allowed. Greater the number of derivatives traded, more the chance of underestimating risk while dealing with leverage. Operational risk plays a major role in developing the risk management programs of a firm.