Key Risk Indicators (KRI’s)

Even though KRI is one of the most familiar terms used amongst the senior management and risk managers, it has not been given its due share of importance amongst other such risk measurement tools. This article focuses on highlighting the typical challenges experienced in organizing a good KRI system.

Some of the key challenges in having an efficient risk indicator are incompatible languages used by different sources, usage of different terminologies, timeliness of reporting the risk profiles to the management, appropriate authority to take necessary mitigating steps and finally clearly defining the risk thresholds.

Incompatible languages
Incompatibility in the language refers to two different dimensions, where one relates to the risk controller in understanding the various evolutions in the market practices and integrating them in the internal risk control framework. This is commonly attributed to the skills and tools or information sources one has access to. The other one pertains to the process of assigning a unified scale for measurement of the inputs received from the various risk indicators since most indicators are specific to individual businesses or processes and generally uncommon in nature.

Use of different terminologies
Often there are disconnects between the operations management teams and operational risk teams on the term ‘Risk Metrics’ and ‘Process Metrics’. The Operations team views their process metrics and in some cases their Service Level Agreements (SLA’s) as the key metrics and holds true as a risk indicator also. A good risk controlling group would consider those factors as risk metrics, which would result in a high impact financial or non-financial loss and it is not uncommon to have some of the process metrics or SLA’s form the sub-sets of risk metrics. Another interesting fact is that one person’s KRI is another’s performance indicator (KPI) and a third person’s service level indicator. Thus, these terminologies differ based on the different perspectives of the users and the activity in which they are engaged.

Timeliness of reporting
This might sound very generic but when you add the essence of risk management, this has the potential to alter the overall outcome of an event. To give a reference from history, imagine the changed scenario if the fax informing US authorities of an attack on Pearl Harbor was reported even a few hours earlier instead of a day late! In the real time corporate environment where every bit of your action is recorded and used in the performance appraisals, there will always be some amount of resistance towards declaring the errors or issues in the system. It is hence very crucial to design the system in such a manner that all such errors or issues are flagged in the best possible timelines. Many times, the operations and risk management groups need to predict the possibilities based on the inter dependability of factors amongst each other.

Right authority
Issue of authority in risk management is one of the major under-currents which has not surfaced much or is not discussed openly in public forums. It is very important for a risk controller or manager to have access to necessary authority to push the right lever at the right time. Unavailability of such authority slowly leads to deterioration of the control effectiveness and thus leads to major losses through undetected or delayed actions on critical risk exposures.

Defining risk thresholds
Risk thresholds can represent or misrepresent the actual risk exposure. This is why it is important to understand that an organization is defining these thresholds not based on the industry benchmark but based on their real time risk appetite. Both the Operations Managers and the Risk Managers need to review it based on a neutral and independent manner. It must be in the common interest of the authorities to define these risk thresholds in a manner that they flash the Red or Amber code also. Many times, it would help to revisit those metrics which are continuously sitting in the Green zone as they might do so because of relaxed risk threshold definitions.

I believe these typical and real time challenges might sound familiar to many of you managing the Operations or Risk portfolios, but with few careful actions and precautions, this tool will work wonders in helping you hit the ‘Bulls eye’ while managing risk in operations.

Challenges in Operational Risk

Some of the key challenges which the risk managers come across as far as operational risk is concerned are:

Early identification of risk exposures
With the ever increasing complexity, irrespective of the sector an industry is catering to, it is always a challenge to detect the potential operational risks in the system. While not all have robust systems or processes which will raise an alarm as soon as an operational factor goes wrong and it is very evident that not all the professionals would want to willingly share the mistakes they did in this highly pink-slip driven world, lays the challenges for the Operational Risk Manager. Many a times there are no second chances to be able to fix the risk from recurring!

Proper categorization of risks
Wondering what further categorization in the Operational risk category? Yes, it is true that there are specific categories within the Operational risk domain, which are based on risk events namely ‘internal events risk’, ‘external event risk’ and ‘business event risk’.

The name itself suggests the meaning of each of these risk characteristics but what is normally overseen is that a risk which is resultant of an external event might eventually turn in to a business event risk and similarly an internal event risk might potentially cause a wide spread external risk which might impact a particular business segment or multiple segments in very high impact cases. Thus, an Operational risk manager needs to be smart and quick in understanding the movements or intentions so to say of any such event risks and take appropriate control measures to prevent it. The word ‘mitigation’ sounds very much embossed on the Operational risk framework, but the best risk manager is one who controllers the risk exposures in a manner which will not lead to the scenario where one has to take mitigating steps.

Methods used for data collection and analysis
This particular challenge is experienced by the operational risk managers in both large scale and small scale organizations in different fashions. The logic is similar to the one between the rich and poor. Like the rich has too much money, and often struggles to find the best use of it the large scale companies too have too much data and at times have too many different sources or methods or tools of collating data that a lot of times they spend developing systems which will integrate all the complex and diverse process divided not just functionally but also in geographies. In case of the small scale industries, like the poor, has to struggle to get relevant data or information to process and perform the necessary assessment. Thus, an operational risk manager, irrespective of the strength of his / her organization, constantly faces the challenge of getting relevant information using which they can understand the risk exposures in their true colours.

Being a ‘Devils Advocate’
It is unfortunate but true that all or many of the risk managers are looked upon as the devils advocate and in some scenarios as actual devils for not approving a lucrative project or for making the busy employees fill a series of check lists and certify their work! It is often a key challenge for an operational risk manager to put forward his point in a forum of senior executives who too are equally keen in the development of their organization, only in a different angle. Many times the operational risk manager’s act based on the treatment he / she will receive for being the devils advocate.

Spreading Operational Risk awareness
It is often said that the operational risk manager has to do so and so things to assess and identify the potential risks. While this is true, the most important factor which proves to be very helpful is the operations team involved in the delivery of their respective products or services to their internal or external clients. As many in operations management feel that their performance is directly proportional to their performance appraisal, it is one of the most common and I believe one of the unavoidable challenges an operational risk manager has to face.

So has all the above inspired you to be an ‘Operational Risk Manager’? If not, I hope the article would have at least helped you in providing the perspective of the Operational Risk Managers in a different light… Happy working!

Nature of 'Operational Risk'

Operational Risk as a process follows a cyclic fashion which revolves around risk identification, risk assessment, determining mitigating actions and setting controls to avoid or minimise the effect of the risk exposures arising out of the business operations. If we have to categorize risks in to two broad categories as ‘financial’ and ‘non-financial’, the loss can result due to human errors, external or internal events, the manner in which the systems or processes operate in a business. Operational risk covers all the above aspects of risk exposure. Does this mean that ‘Operational Risk Control’ is all that is required to save an organization or business from doom? The answer is ‘No’; it is certainly not the only process contributing towards risk management, as Market Risk & Credit Risk too has its due share. But the key differentiator between the other risk management process from that of Operational risk is the nature of its application in the business environment. To further simplify, there are pre-defined models to manage Credit / Market risks, whereas there is no specific model or application to bank on, as far as Operational risk is concerned. It is hence considered more dynamic in nature compared to other risk segments.

As represented in the pictographic representation of the Operational Risk Framework, the core of the Operations risk governance model of Assessing the risk exposures or incidents, placing controls, monitoring the performance of those controls and initiating necessary actions as required are carried out by scheduling appropriate set of processes, technology and of course the human resource. All the above comes together to ensure ‘Confidentiality’, ‘Integrity’ and ‘Availability’ of the assets of any organization.