What defines operational risk in an organization?

Operational risk in an organization is primarily defined as the risk of losses stemming from inadequate or failed internal processes, systems, personnel, or external events. This encompasses a wide range of potential issues, including operational inefficiencies, technical failures, human error, and even fraud.

The significance of this definition is that operational risks arise primarily from the day-to-day functioning of a business and its operations. For instance, if an organization experiences a breakdown in its processes—whether this pertains to transaction processing, system outages, or lapses in compliance—it may result in financial losses, reputational harm, or reduced operational effectiveness.

Other types of risks mentioned, such as market fluctuations and credit defaults, fall under different categories of risk. Market risk relates to the potential losses due to changes in market prices, while credit risk is associated with the possibility of clients or counterparties failing to fulfill financial obligations. Failing to meet service level agreements is a specific outcome that may arise from operational shortcomings, but it does not encompass the broader scope of what operational risk entails. Thus, recognizing the comprehensive nature of operational risk highlights why the definition centered around inefficiencies in internal processes is accurate and fundamental to risk management strategies in organizations.