Operational Risk: The Next Risk Management Frontier.

Although it has only recently begun to attract the attention it deserves, operational risk represents a pervasive exposure for financial institutions. Fortunately, there is a plan of attack.

Risk Management Alert presents a nine-part risk management menu, serving up a look at credit, operational, market, asset/liability management, regulatory/ compliance, privacy, fair lending/CRA, and strategic risk. Risk specialists from Ernst & Young LLP provide this series.

With all of the changes in the financial services industry over the past several years, one key change in risk management has been a growing focus on operational risk. Today, most of the largest institutions have developed initiatives aimed at improving their management of operational risk--an exposure that few industry executives had given much attention just two years ago.

Operational risk is the risk of loss caused by deficiencies in information systems, business processes, or internal controls as a result of either internal or external events. Operational risk encompasses risks emanating from all areas of the organization, from the front office to the back office and support areas. Examples include systems failures, the faulty execution of a transaction, incorrect data entry, fraud, natural disasters, and regulatory changes. Over $7 billion in operational risk losses by financial services firms was reported in the press last year, representing only a fraction of the actual losses incurred.

Drivers of Change

While operational risk is not new, the increased recognition of such risks in executive suites is being driven by changes in the business, regulatory, and operating environment. These changes are the result of an accelerating speed of change and increasing business scale that are being fueled by e-commerce and mergers/acquisitions as well as an increased focus on high-volume, fee-based activities. These pressures have generated increasing losses and made business activities and failures more transparent to the customer. This dynamic business environment is increasing the level of exposure to operational risks while at the same time increasing the impact of losses, both in financial and reputational terms.

Furthermore, the …