What is operational risk?

Operational risk refers specifically to the potential for losses that arise from inadequate or failed internal processes, systems, or external events. This encompasses a wide range of issues including, but not limited to, fraud, mismanagement, system failures, and other disruptions that can affect the smooth functioning of an organization.

The definition of operational risk highlights its focus on internal mechanisms rather than external market conditions. This makes it distinct from other types of risk, such as economic risk, which refers to broader economic factors affecting the business environment, or market risk, which deals with fluctuations in financial markets. By identifying operational risk as the risk of loss due to failure in processes or systems, it underscores the importance of robust internal controls and risk management frameworks within organizations to mitigate such risks.

In summary, the correct understanding of operational risk involves recognizing that it fundamentally stems from the organization's operational capabilities and how these can be compromised, leading to financial losses.