Operational Risk and the relationship with Lean Six Sigma
22 May 2012

As we all know, the world of recruitment is a fast paced one, one in which you will not succeed without a clearly defined path and strategy. With this in mind, and an in depth analysis of Lean 6 Sigma methodology it appeared prudent to define an area of expertise for myself. From the first time I learned of Lean methodology, it appeared to me to fit in ideally with the concepts of Operational Risk.


Operational risk is, as the name itself suggests, a risk coming from the poor or improper execution of a company's business functions. It is of course an extremely open concept, one which focuses on risks arising from the people within a company, as well as the systems and processes through which a company operates. As well as this it encompasses wastage, fraud risks and the possibility of legal risks. Operational risk is something to me that all modern businesses should want to manage in the most efficient way, to cut down on, to reduce wastage, reduce man-hour wastage and as a result, save money.


A widely used definition of operational risk is the one contained in the Basel II regulations, "The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events." This definition states that operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.


However, the Basel Committee recognizes that operational risk is a term that has a variety of meanings and therefore, for internal purposes financial institutions often (legally) adopt their own definitions of operational risk, provided that the minimum elements in the Committee's definition are included.


The Lean Six Sigma methodology views lean manufacturing, which addresses process flow and waste issues, and Six Sigma, with its focus on variation and design, as complementary disciplines aimed at promoting "business and operational excellence". Companies such as IBM use Lean Six Sigma to focus transformation efforts not just on efficiency but also on growth. It serves as a foundation for innovation throughout the organization, from manufacturing and software development to sales and service delivery function.


The approach to managing operational risk differs from that applied to other types of risk, because it is not used to generate profit. In contrast, credit risk is exploited by lending institutions to create profit, market risk is exploited by traders and fund managers, and insurance risk is exploited by insurers. They all however manage operational risk to keep losses within their risk appetite - the amount of risk they are prepared to accept in pursuit of their objectives. What this means in practical terms is that organisations accept that their people, processes and systems are imperfect, and that losses will arise from errors and ineffective operations. The size of the loss they are prepared to accept, because the cost of correcting the errors or improving the systems is disproportionate to the benefit they will receive, determines their appetite for operational risk.


Of course, I believe that these two philosophies tie in together ideally. With the adopting of better Lean processes and better management of Lean manufacturing, Operational Risk can be cut down, and by the recruiting of the best Lean professionals within Operational Risk, businesses can grow.