Slide MGT305 Slide12

Operational Risk
Chapter XX

What Is Operational Risk?
• Operational risk is the risk of loss resulting

from inadequate or failed internal
processes, people, and systems or from
external events.
• This definition includes legal risk but does

not include business risk such as
reputation risk and strategic risk.

Determination of Regulatory
Capital

• Banks have three approaches in determining
operational risk regulatory capital.
• The simplest approach is the basic indicator

approach where operational risk is set equal
to 15% of annual gross income (net interest
income plus noninterest income) over the
previous three years.

Determination of Regulatory
Capital

• Another approach is the standardized

approach that divides bank’s activities into
eight business lines.
• The average gross income over the last three

years for each business line is multiplied by a
“beta factor” for that business line and the
result summed to determine the total capital.

Determination of Regulatory
Capital

Business line

Beta factor

Corporate finance

18%

Trading and sales

18%

Retail banking

12%

Commercial banking

15%

Payment and settlement

18%

Agency services

15%

Asset management

12%

Retail brokerage

12%

Determination of Regulatory
Capital

• The last approach is the advanced

measurement approach (AMA) in which
operational risk regulatory capital
requirement is calculated by the bank
internally using qualitative and
quantitative criteria.