Basel II defines operational risk as the risk of loss resulting from inadequate or failed processes, people and systems or from external events. This definition includes legal risk but excludes strategic and reputational risk.
The operational risk concept embraces many different elements and dimensions. Risks attached to systems and processes are tangible, easier to quantify and easier to attach a risk owner with accountability and authority to manage these risks.
The human dimension is complex and difficult to define. However its importance is increasing. Ferma’s 2012 benchmarking survey showed that the risk importance perceived by the respondents increased from 15 % in 2010 to 21 % in 2012 for human resources/ key people, social security (labour).
- Elements of human (resources) risk
This risk is defined from different angles by different sources. However there is consensus about that it includes following elements:
– Internal fraud
– External fraud
– Risk attached to the human element in execution, delivery and process management
– Risk attached to business and client/ customer practices
– Employment practices and working environment
I think that the most complete definition is provided by wikinvest.
“…Risk that the group may incur losses due to drain or loss of personnel, deterioration of morale, inadequate development of human resources, inappropriate working schedule, inappropriate working and safety environment, inequality or inequity in human resource management or discriminatory conduct…”
Fraud and safety issues with tangible and measurable adverse effects are focused on by many companies and institutions. However focusing solely on these elements may represent an underestimation.
- Why is human (resource risk) underestimated ?
There are many reasons for this and in the following I will pinpoint only some of them:
- ISO 31000 defines risk as effect of uncertainty on objectives. The uncertainty may create both positive and negative consequences. Focusing on negative consequences i.e. safety environment, fraud etc. is a necessary condition for sound risk management. However it is not a satisfying condition. Such approach will underestimate the behavioral issues as deterioration of morale, reduced motivation, malfunctioning working environment, loss of personnel. Companies may realize considerable gains by widening their focus and think about the opportunities attached to behavioral aspects of human risk.
- Some human resource risk elements have lagged consequences. As an example, a poor working environment may result in reduced motivation, sick leaves, loss of personnel with a lag depending on the people and company in question. When consequences are lagged and not obvious, they may be underestimated. When consequences are underestimated, the risks too will be underestimated.
- Human resource risk is correlated with other risks. Legal risk, reputational risk, financial risk etc. Initial consequences of the risk may be escalated by knock-on effects. Hidden in other risks the human resource risk may, per se, be underestimated.
- The external context plays an important role for the perception of the human resource risk. In many countries and many industries the supply of labor exceeds the demand. The companies and institutions do not have the pressure to retain, develop and motivate their resources as it would be the case otherwise.
- Understanding human resource risks necessitates a multidisciplinary approach. The Board, senior management and the risk manager needs assistance for identifying, analyzing, evaluating and treating human resource risk. The risk will be owned and monitored collectively by several entities in a company, inclusive of HR- department. If left in a silo, the risk will be underestimated.
- Quick, one size fits all fixes may not be the appropriate treatment of this risk. Many consultants and many risk managers try to monitor all types of human resource risks with rules and procedures only. Behavioral elements of human risk are affected by the company values and culture and with how the management walks its talk. Solely procedure- oriented approach may leave a considerable risk residual untreated.
The results of Ferma’s 2014 benchmarking survey will be available soon. I look forward to see how the recipients have classified the importance of this risk and how it is managed now. It will give insights for my further work.