Using Internal Loss Data to Mitigate Operational Risks
The modern approaches to risk management are data-driven. There are four basic steps to this approach which we will study later in this module. The first step contains information about how data related to internal losses suffered by an organization needs to be collected and studied in order to better mitigate risks in the future. Loss data also needs to be collected from external sources such as peers and industry members. However, we will study the external loss data analysis in the next article.
In this article, we will focus on what internal loss is, how a system can be created to collect internal loss data and how such data can be utilized to manage operational risks more effectively.
What is Internal Loss?
Internal losses are losses that have arisen due to failed processes or incompetent people within the organization. The losses which occur may be financial or non-financial in nature. The objective of analyzing internal loss is:
- to categorize the operational losses by functions such as technology, human resources, marketing, etc
- to categorize operational risks by product categories, locations, and even by manager
- to identify and categorize risks that may come into play if the company decides to outsource some of its internal processes
- to create a priority list of all the internal risks so that appropriate risk mitigation mechanisms can be employed.
Collection of Internal Loss Data
Before data regarding internal loss is collected from the various parts of the organization, it is essential to generate buy-in from the different stakeholders. This is because organizations are by nature forward-looking. If the management asks for extensive data collection about past events, it is likely that they may face some resistance. Loss data collection is an exhaustive process. When implemented, it becomes part of the daily duty of every employee across the organization and a part of the daily business and usual functioning.
The objectives of loss data collection and the benefits that will be derived from it must be explained to all stakeholders in order to avoid issues later on.
Shortcomings of Internal Loss Data
There are several obvious benefits to internal loss data collection. However, there are several shortcomings as well. Some of them have been mentioned below:
The bottom line is that the collection of internal loss data is an integral part of the operational risk management process. The end result of this data collection is the creation of a loss database that can be used to better predict and mitigate future risks. This is the reason why this approach is suggested in the Basel II norms and is likely to be implemented in major organizations all across the world.
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