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What is operational risk?

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The risk of loss due to inadequate or failed internal processes, people and systems or from external events is operational risk.  Errors in data, books and records; omissions in the structuring, documentation or maintenance of a transaction; deficient internal controls; incompetent personnel; fraud; and failure in IT systems are examples of operational risk.  Three significant operational risks that lessors are exposed to are legal and compliance risk, strategic risk and reputational risk.

Legal and compliance risk is the risk of financial loss arising from the government and regulatory environment, compliance with policies and procedures, and legal action and proceedings.  For example, improper documentation of a lease could result in the lessor losing its contractual rights under the lease as well as its ability to realize tax benefits or take advantage of the rights of asset ownership. 

The risk to an organization due to its failure to realize and fully integrate its activities with its business plans and strategic goals and direction is strategic risk.  Strategic risk includes the risks associated with the macro environment in which a lessor operates; mergers and acquisitions and restructuring activity; intellectual property rights; demand for products and services; competitive threats, technology and product innovation; and public policy.

Reputational risk is the risk of loss resulting from damages to a firm’s reputation when its character or quality has been called into question.  Its sources for a lessor include failure to meet its legal or fiduciary responsibilities, termination or modification of leases, repossession and liquidation of leased assets as well as material credit losses.  This risk is a major – if not the greatest – threat to a company’s market value.

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