What is Compliance Risk: Meaning, Types, Examples & Best Practices

Global regulations and accessibility are growing rapidly, and so is compliance risk for businesses. In this article, we will explore compliance risk meaning and list its types and examples. You will also learn about the top 10 compliance risks and discover the best practices for reducing compliance risk.

What is compliance risk? 

Compliance risk can be defined as the potential damage that a business faces when there is a failure to comply with the industry standards, laws and regulations. There are both financial penalties and reputational damage associated with compliance risk. Also, whether an organisation is big or small, all are exposed to compliance risks. 

Types of compliance risks

Now that you know what is compliance risk, let’s explore its types: 

1. Regulatory risks: This type of compliance risk arises when laws such as the Information Technology Act, the Personal Data Protection Bill, and the Companies Act are not followed. Any failure to address this risk can lead to legal penalties and fines. 
2. Industry standards: This type of compliance risk is associated with the ISO or QCI standards. If there is any discrepancy, it may lead to loss of business opportunities and revenue, since clients always demand adherence to specific guidelines. 
3. Internal policies and practices: Lastly, this type is related to internal policies. In case of non-compliance, it can lead to various risks like data mishandling or IT security breaches. It becomes important to comply with internal standards for eliminating this risk effectively. 

Top 10 compliance risks

Apart from the types, here are the top 10 compliance risks that you should be aware of:

1. Payment card data breach: If there is an unauthorised access to the payment card information it poses a significant threat to your business. It is essential to have compliance with the PCI Data Security Standard (PCI-DSS) for preventing such breaches. 
2. Data privacy infringement: For violations of data protection regulations in India, there can be significant financial penalties and reputational harm.  Ensuring compliance with the Information Technology Act (IT Act) and its associated regulations is crucial.
3. Lack of disaster preparation: The disruptions in the business are caused by unforeseen disasters. It becomes necessary to establish a robust recovery plan for minimising downtime and ensure business continuity. 
4. Regulatory and political uncertainty: Political influences and the changing regulations have a direct impact on the business operations. To remove the associated risks, businesses must stay updated in the regulatory changes and adapt strategies accordingly. 
5. Conflicts of interest: The integrity gets compromised when there is a personal interest conflicting with the organisational goals. To prevent it, clear guidelines on ethical conduct and maintaining transparency can help. 
6. Market risk: A significant risk is posed to the businesses by the risks associated with the fluctuating markets. This risk can be mitigated with the help of informed decision making, and monitoring industry trends .
7. Conduct risk: The organisation’s reputation is harmed if there are legal issues due to internal misconduct such as harassment or discrimination. Clear codes of conduct must be established and disciplinary actions should be there to prevent conduct related risks and promote a positive work environment.  
8. Corruption: Fraud and bribery can lead to legal consequences and damage the integrity of the organisation. It becomes important to provide training to the employees and implement monitoring mechanisms for preventing corrupt practices and making sure there is compliance with the anti-corruption laws. 
9. Quality: Reputational damages and penalties always follow the subpar products or services. To eliminate the risks associated with the poor quality, customer satisfaction must be prioritised and there should be adherence to quality standards. 
10. Social responsibility: If there is a failure to fulfil social responsibilities, it can lead to negative public perception and eventually boycotts. This risk can be mitigated by committing to social causes and aligning with the community expectations. 

Impact of compliance risk

Compliance risk can affect many areas of your business. Here’s how:

• Reputational impact: If you fail to comply with the standards and the regulations, it can severely damage your reputation. This will also erode the trust among the customers and make it challenging to maintain your business relationships. 
• Business disruption: Non-compliance can also disrupt your business operations and lead to shutdowns. For instance, if there is a failure in the Payment Card Industry Data Security Standard requirements, it will lead to the rejection of your major credit cards and impact your revenue and customer loyalty. 
• Financial consequences: Compliance risk has a major impact on the finances. Your bottom line will be severely impacted by the lost revenue, investors and the legal fees that you will have to pay in case of breaches. 
• Legal ramifications: When there is a non-compliance with the standards and best practices, it can result in legal action against your organisation and employees. It may ultimately lead to a company shutdown. 

Compliance risk examples

Two common examples include:

• Ignoring software updates: When there is a failure to update the software, it leaves the business vulnerable to cyberattacks. For example, in the Equify data breach, outdated software allowed the attackers to steal the date of millions of users. 
• Neglecting data audits: For industries handling sensitive data, lack of auditing the data can pose a significant compliance risk. If the audit trail is maintained, it will help in forensic analysis during and after the date breaches. 
• Not registering for GST when required: Businesses that meet the registration threshold but fail to register will miss out on claiming input tax credit (ITC) and may face penalties for non-compliance, resulting in hefty fines and legal consequences that impact the business's financial health and reputation.
• Issuing incorrect invoices: Invoice errors, like missing GST details or incorrect tax rates, can lead to disputes, payment delays, and challenges in claiming ITC, impacting cash flow and compliance.

How to assess compliance risk?

There are several steps to assess compliance risk:

• Identify the risks: Ascertain whether there is any compliance gap within your organisation and gather together all regulatory requirements.
• Strategise protection: Understand which department and outcome will be facing the possible problem and then make out a strategy according to it. 
• Assess the impact: Employ quantitative or qualitative measures to assess the probability of the risk and its impact. 
• Prioritise critical risks: Deal with the compliance risks, identify their priority level on a scale based on probability and severity of impact for your business. 
• Identify risk response actions: Select a response action, develop a treatment plan, and share with stakeholders for their input and concurrence.
• Evaluate residual risk: When chosen actions have been implemented evaluate their effectiveness. Assess if there is any remaining risk. If out of acceptable level then additional controls should be implemented for residual risks.
• Conduct periodic evaluations: Make sure that you carry out regular assessments of compliance risk. This will help you re-estimate your exposure to danger as well as confirm that compliance is still in place.

How to reduce compliance risk?

Apart from accessing the compliance risk , you can apply the following strategies to reduce it:

• Identify applicable laws and regulations: Start by understanding the relevant laws, regulations and standards that are applicable to your business operations and industry.
• Assess compliance gaps: Identify the areas where your organisation is failing to meet the legal requirements. This will include reviewing the internal policies, procedures and practices.
• Implement controls and procedures: After you are done with identifying the compliance gaps, try to implement controls and procedures for addressing them. This will include upgrading your internal policies, improving your training programs and enhancing your monitoring systems.
• Stay informed about updates: Keep tracking the changes and updates regularly. Monitoring laws, regulations and industry standards will help you remain compliant and quickly adapt to any new requirements. 

Best practices for managing compliance risk

Here are some essential best practices for effectively managing compliance risk:

• Prioritise risk assessment: Begin with a comprehensive risk assessment for effectively managing compliance risks. Understanding the risks will enable you to prioritise resources and efforts and make your strategies more effective and targeted. 
• Evaluate third-party risks: Third parties often pose significant risks, and it is important to assess the risks associated with them. Categorise and screen third parties using due diligence software to prevent any potential compliance issue. 
• Leverage automation tools: It is also important to automate the mundane tasks such as employee signatures and retrieving records. Use an automated email archiving and policies and procedures management software to streamline the compliance processes, save time, and reduce the errors. 
• Cultivate an ethical culture: Try implementing a culture of ethics and compliance. Communicate the standards clearly and provide engaging training. Use tools to reinforce policy understanding among the employees. 
• Regularly revise compliance policies: In order to address the emerging risks and the internal changes, review and update the compliance policies regularly. Treat compliance as an ongoing effort to avoid costly breaches and ensure robust risk management. 

To sum up, managing the compliance risk demands staying alert and sticking to the best practices. Businesses can reduce the impact of compliance issues on their operations by placing their focus on assessing the risks, staying updated on regulations, adopting the technology and promoting a culture of compliance and ethics.