Operational Risk Management (ORM) is a structured approach organizations use to proactively manage uncertainties that could negatively impact their goals. This methodology provides a standardized framework for anticipating potential failures and making informed decisions across all operational activities. Understanding ORM requires examining its formal definition, underlying philosophy, and the specific sequential process applied in its execution.
Defining Operational Risk Management (ORM)
Operational Risk Management is formally defined as the process of identifying, assessing, and controlling risks arising from day-to-day business operations. These risks stem specifically from inadequate or failed internal processes, human error, system malfunctions, or unpredictable external events. This category of risk is distinct from strategic risk, which involves high-level organizational decision-making, or financial risk, which relates to market volatility and credit exposure.
ORM focuses on the internal mechanisms of an organization to minimize potential loss and maximize the successful execution of daily tasks. The goal is to ensure a stable, reliable operating environment where resources are protected and organizational objectives are consistently met.
Categorizing ORM: A Systematic and Cyclical Process
Operational Risk Management is defined as a systematic, cyclical, and decision-making process used by organizations to manage hazards. Its systematic nature requires adherence to a structured methodology and a fixed sequence of steps, ensuring consistency and thoroughness in risk analysis.
ORM is cyclical because its final step feeds directly back into the beginning, creating a continuous feedback loop rather than a single, linear activity. This continuous nature ensures that lessons learned from past operations are incorporated into future planning and execution. The process functions as a decision-making tool, providing leaders with the necessary information to evaluate risk levels and choose the most appropriate course of action based on potential consequences.
The Guiding Principles of Operational Risk Management
The application of the ORM process is governed by foundational principles that guide organizational philosophy toward risk acceptance and mitigation. Personnel must accept risk only when the potential benefits clearly outweigh the associated costs of exposure.
Organizations must accept no unnecessary risk; any exposure that does not contribute meaningfully to the mission must be eliminated or mitigated entirely. The process must also be fully integrated into planning at all organizational levels, making risk management an inherent part of every decision. Finally, risk decisions must be made at the appropriate level of leadership, ensuring the individual accepting the risk has the authority and resources to manage potential consequences.
The Five-Step Operational Risk Management Process
The formalized ORM methodology is executed through a sequential, five-step process designed to move systematically from hazard awareness to operational control. Each step builds upon the output of the preceding one, ensuring a comprehensive analysis before control measures are finalized and implemented.
Identify Hazards
This initial phase focuses on identifying potential hazards, defined as any existing or potential condition that can cause harm, damage, or loss. This involves a thorough analysis of all operational components, including the environment, equipment, personnel actions, and planned tasks. Techniques such as brainstorming, historical data review, and expert consultation are employed to systematically uncover every source of potential failure.
Assess Risks
This step involves quantifying the potential for loss associated with each identified hazard. Quantification is achieved by evaluating two main factors: the probability or likelihood of the hazard occurring, and the severity or impact if it were to materialize. Risk matrices are often used as a standard tool, plotting likelihood against severity to generate a definitive risk level, such as low, medium, or high. This ranking provides an objective measure of the threat, allowing leaders to prioritize hazards requiring immediate attention.
Analyze Risk Control Options
This third step involves developing and analyzing various control options to eliminate or mitigate the identified hazards. Controls can include engineering solutions, administrative procedures, or personal protective equipment designed to reduce either the likelihood or the severity of the risk. This analysis evaluates the feasibility and effectiveness of each potential control measure to determine the optimal strategy.
After analyzing controls, a final risk decision must be made: accepting the risk as is, mitigating it through the developed controls, or avoiding the operation entirely. This decision considers the cost-benefit ratio of the controls and determines the residual risk—the level of risk remaining after implementation.
Implement Controls
Implementation is the action phase where selected controls are formally put into effect across the operating environment. This requires clearly communicating the chosen controls and procedures to all affected personnel, ensuring a universal understanding of the new operating standards. Resources, such as physical equipment or training time, must be allocated to support the effective deployment of the mitigation strategies.
Supervise and Evaluate
Supervision and evaluation is the final step, which closes the loop of the ORM process. This phase requires constant monitoring of implemented controls to ensure they are functioning as intended and effectively reducing the anticipated risk. Personnel must observe the operation for any unintended consequences or new hazards introduced by the controls themselves. The collected data and lessons learned are then documented and fed back into the initial identification phase, ensuring the organization continually improves its risk management methodology.
The Scope and Application of ORM
The methodology of Operational Risk Management is broadly applicable across diverse sectors where reliable operations are paramount to success and safety. This structured process is standard practice in high-reliability organizations like the military and aviation, where failure carries catastrophic consequences. It is also routinely employed in healthcare settings to manage patient safety risks, in major infrastructure projects, and within the finance sector to manage internal procedural failures.
The application of ORM spans different time horizons. It includes deliberate planning, which involves long-term, detailed analysis during the design phase. It also extends to time-critical application, where leaders must execute the core steps of the process rapidly and in real-time to manage immediate, evolving hazards.