Technological risk

What Is Technological Risk?

Technological risk refers to the potential for losses or harm arising from the failure, inadequacy, or misuse of technology systems. This category of risk management encompasses a broad spectrum of issues, from software glitches and hardware failures to cybersecurity breaches and the unforeseen consequences of innovation. Organizations across all sectors increasingly rely on information technology to operate, process data, and deliver services, making the effective management of technological risk a critical component of their overall risk management framework. It includes direct financial losses, as well as indirect impacts on reputation, compliance risk, and operational continuity.

History and Origin

While the concept of risk associated with tools and machines has existed for centuries, "technological risk" as a distinct financial and operational concern emerged prominently with the advent of widespread computerization and digitalization in the late 20th century. Early concerns often centered on system failure due to hardware malfunctions or software bugs. As computer networks grew and the internet became ubiquitous, the scope of technological risk expanded dramatically to include vulnerabilities like hacking, data corruption, and unauthorized access.

Major incidents, such as the widespread "Y2K bug" scare at the turn of the millennium, highlighted the interconnectedness and potential fragility of global information technology systems. More recently, large-scale data breach events, like the one experienced by Equifax in 2017 which exposed sensitive personal information of millions of consumers, underscore the pervasive nature of these risks. The Federal Trade Commission (FTC) detailed how the breach resulted from the failure to patch a known security vulnerability, emphasizing that basic security measures were not implemented.¹³, ¹⁴, ¹⁵ The continuous evolution of technology, including the rise of artificial intelligence and distributed ledger technologies, ensures that technological risk remains a dynamic and evolving area of concern for financial institutions and other entities worldwide.

Key Takeaways

• Technological risk stems from the failure, inadequacy, or misuse of technology systems, encompassing hardware, software, and networks.
• It is a core component of operational risk and can lead to financial losses, reputational damage, and business disruption.
• The continuous evolution of technology, including new forms of innovation, means that technological risk is a dynamic and ever-present challenge.
• Effective management requires robust cybersecurity risk measures, proactive system maintenance, and comprehensive incident response plans.
• Organizations must adapt their risk management strategies to address emerging threats like sophisticated cyberattacks and vulnerabilities in third-party vendor relationships.

Interpreting Technological Risk

Interpreting technological risk involves assessing the likelihood of a technology-related event occurring and the potential severity of its impact. This assessment often considers factors such as the age and complexity of existing systems, the robustness of cybersecurity risk controls, the organization's reliance on third-party technology providers, and the pace of technological change within its industry. A high technological risk profile might indicate a need for significant investment in infrastructure upgrades, enhanced security protocols, or revised operational risk management strategies.

For example, a financial services firm heavily reliant on legacy IT systems might face higher technological risk compared to one that regularly updates its infrastructure and adopts modern security practices. Beyond the technical aspects, interpretation also involves understanding the potential for business disruption, regulatory penalties, and damage to reputational risk if a technological incident occurs. Effective interpretation informs investment decisions and strategic planning, ensuring that technology advancements align with an acceptable risk appetite.

Hypothetical Example

Consider "TechCo Innovations," a startup specializing in developing a new cloud-based artificial intelligence platform for small businesses. TechCo's primary asset and service delivery mechanism is its proprietary software.

Scenario: TechCo experiences a significant distributed denial-of-service (DDoS) attack.

• Initial Impact: The attack overwhelms TechCo's servers, rendering its platform inaccessible to all customers. This immediately halts service delivery.
• Financial Impact: As TechCo's revenue model is subscription-based, extended downtime leads to direct revenue loss and potential customer churn. Remediation efforts incur additional costs, including emergency IT support and increased server capacity.
• Reputational Impact: Customers, unable to access critical business tools, voice frustration on social media, leading to negative press and damage to TechCo's brand. Potential new customers reconsider signing up.
• Operational Impact: TechCo's internal teams are diverted from product development and customer support to crisis management, disrupting their normal operations.
• Long-term implications: Even after the attack is mitigated, TechCo might need to invest heavily in more robust cybersecurity risk defenses, potentially delaying product roadmap advancements. Customers may demand service level agreements (SLAs) with stricter uptime guarantees, impacting future pricing models.

This example illustrates how a single technological incident, in this case, a cyberattack, can cascade into various forms of harm, encompassing financial, reputational, and operational dimensions.

Practical Applications

Technological risk is a key consideration across numerous domains:

• Corporate Governance: Boards of directors and senior management must oversee technological risk as part of their broader enterprise risk management duties. This includes setting risk appetites, approving IT security budgets, and reviewing incident response plans.
• Investment Due Diligence: Investors conducting due diligence on tech companies or businesses heavily reliant on technology will scrutinize their technological risk management frameworks. A weak framework could signal potential instability or future financial liabilities, impacting investment decisions and portfolio management strategies.
• Regulatory Compliance: Regulators in sectors like finance, healthcare, and critical infrastructure impose strict requirements on managing technological risks, especially cybersecurity risk and data protection. For instance, the Federal Reserve Board has emphasized effective information technology risk management as critical to the safety and soundness of financial institutions and the stability of the financial system.¹¹, ¹²
• Product Development: Companies developing new technologies must assess the inherent risks of their products, from design flaws to potential misuse. This includes anticipating how new features might introduce vulnerabilities or ethical dilemmas.
• Supply Chain Management: As businesses increasingly rely on third-party software and service providers, managing technological risk extends to assessing and mitigating vulnerabilities within the supply chain. A breach or system failure at a vendor can directly impact the client organization. The National Institute of Standards and Technology (NIST) provides a widely adopted Cybersecurity Framework to help organizations manage and reduce cybersecurity risk, including considerations for the supply chain.⁷, ⁸, ⁹, ¹⁰

Limitations and Criticisms

While essential, the assessment and mitigation of technological risk face several inherent limitations and criticisms:

• Rapid Evolution: Technology evolves at an unprecedented pace, making it challenging for risk management frameworks to keep up. New threats, vulnerabilities, and types of disruption emerge constantly, potentially rendering existing controls obsolete.
• Complexity and Interconnectedness: Modern IT systems are often highly complex and deeply interconnected, both internally and with external third parties. This complexity can make it difficult to identify all potential points of failure or predict the ripple effects of a localized incident.
• Human Factor: A significant portion of technological risk arises from human error, negligence, or malicious intent. Despite robust technical controls, human factors like insufficient training, weak password practices, or insider threats can create critical vulnerabilities.
• Cost vs. Benefit: Implementing comprehensive technological risk mitigation strategies can be extremely expensive, requiring substantial investment in hardware, software, expert personnel, and training. Organizations constantly grapple with balancing the cost of protection against the perceived likelihood and impact of various risks.
• Quantification Challenges: Accurately quantifying technological risk in financial terms remains a significant challenge. While direct costs of a data breach can be estimated, indirect costs such as reputational risk, loss of competitive advantage, or long-term customer attrition are difficult to measure precisely. The International Monetary Fund (IMF) has highlighted how cyberattacks pose a threat to financial stability, with reported direct losses in the financial sector amounting to billions, though total losses are likely higher when indirect impacts are considered.⁵, ⁶

Technological Risk vs. Operational Risk

Technological risk is often confused with operational risk because technology is integral to most modern operations. However, technological risk is a subset of operational risk.

Essentially, while all technological risks are operational risks, not all operational risks are technological. A bank's system failure due to a software glitch is a technological risk and, by extension, an operational risk. However, a bank experiencing financial losses due to internal fraud committed by an employee (a "people risk") is an operational risk but not a technological risk, although technology might be used in the fraud. Regulators, such as the Federal Reserve, emphasize the importance of managing operational risk, explicitly including technology and cybersecurity risk as key components.¹, ²

FAQs

What is the primary cause of technological risk?

Technological risk can stem from various sources, including hardware failures, software bugs, human error, external cyberattacks, natural disasters impacting infrastructure, and even unforeseen consequences of new technologies.

How do organizations manage technological risk?

Organizations manage technological risk through a combination of strategies, including implementing robust cybersecurity risk measures, maintaining and upgrading IT infrastructure, establishing clear information technology policies and procedures, conducting regular audits and vulnerability assessments, training employees, developing comprehensive disaster recovery and business continuity plans, and securing strong third-party vendor agreements.

Can technological risk be entirely eliminated?

No, technological risk cannot be entirely eliminated. Due to the dynamic nature of technology, the emergence of new threats, and the inherent human element, some level of risk will always remain. The goal of risk management is to identify, assess, mitigate, and monitor these risks to keep them within an acceptable tolerance level for the organization.

What is the difference between technological risk and cybersecurity risk?

Cybersecurity risk is a specific type of technological risk that focuses on threats related to unauthorized access, use, disclosure, disruption, modification, or destruction of information and information systems. While all cybersecurity risks are technological risks, technological risk is a broader category that also includes non-malicious failures like hardware malfunctions or software glitches.