Operational Risk in a Recession

South Africa entered its first recession in 17 years earlier in 2009 after experiencing two consecutive quarters of economic growth. The ensuing job losses, repossessions and company liquidations placed everyone in survival mode for the foreseeable future.

But what if we could reflect and learn from our mistakes and methodically and confidently prepare for the next wave of economic growth?

Operational risk (OR) can be used to build a case to support key initiatives required to position an organisation for the next growth cycle.

Operational risk is defined in Basel II as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk. Typical components of an OR framework includes:

Loss Data Collection - With a standardised event & risk classification framework organisations can collect data on losses realised due to control failures or external factors. This process can be further optimised with commercially available external loss data sets (e.g. FITCH, ORX, etc)
Risk and Control Self-Assessment- The RCSA process establishes a systematic approach to evaluate the inherent risks across business activities and the associated controls for mitigation.
Issues and Action Plans– When a control is breached during the RCSA process, an ORM framework allows for the reason for the control breach to be articulated and linked to an Action Plan with a finite time horizon for resolve.
Key Indicators– Key Indicators provide the predictive risk management capacity across various business activities at a specific point in time. Through correct calibration and continuous monitoring KRI’s reveal the areas in the business most susceptible to failure in the event of common shocks.
Scenario Analysis & Stress Testing– The concept of Scenario Analysis in ORM is unique in bringing together quantitative and qualitative information through a structured approach. It has enabled organisations to obtain a clearer understanding of correlations and dependencies, as well as the allocation of economic capital.

With the OR framework as our reference, we can target the following activities to deliver measurable business benefit during a recession. These include:

Business Re-Baselining– Using the Loss Data Collection and Key Indicators, businesses can “reset” these predictive trigger points (such as transaction volumes or value at risk figures).
Process De-Risking– Using risk and control self-assessments businesses can identify the common control failure points and remediate these based on industry best practices. By including a risk sensitive view of their core business process, organisations are able to understand their capacity and capability requirements from a tactical and strategic standpoint.
Risk Experience Update– By updating loss data collection with internal and external data, businesses can better understand the impact of risks.
Cost Benefit Analysis– Consecutive terms of economic growth usually allows business inefficiencies to go unnoticed. A focus on cost reduction through a recession allows business to critically look at the cost of existing controls, decide which are critical, and decommission or restructure their business to save money.
Synergy Identification– Benefiting from a boom and recession cycle, organisations can model the impact of risk scenarios on their business. This allows organisations to model more complex concepts such as strategic and reputational risk.

Operational risk management touches all parts of an organisation and can be used as an effective tool in translating past risk experiences into competitive advantage. By contributing to the “organisational memory”, operational risk prepares management for the next phase of growth in a manner which is sustainable and efficient.

By Vanessa Payne