VI. Examples
A. Basic Indicator Approach
The Basic Indicator Approach (BIA) is a simple approach for calculating the capital charge for operational risk. It can be used by banks that are not internationally active, as well as by banks that are internationally active but may not as yet have risk management systems in place for using the more advanced approaches for measuring operational risk. Below is an example of ABC bank and how the Operational risk capital charge is calculated on Basic Indicator Approach
1- Calculating gross income through the table shows part of the income statement of ABC bank for 2003.
Income statement of ABC bank for 2003 Operating income Interest income 150 Interest expenses 110 Provisions made 20 Net interest income after provisions 20 Fees and commissions received 80 Fees and commissions paid 50 including fees paid for outsourcing 12 Other income
From disposal of subsidiaries
From disposal of available for sale
Investments
10
8
0Net non-interest income 48 Total operating income 68 The net interest income to be used in gross income for calculating the operational risk capital charge after provisions. Normally banks reduce this amount to arrive at the operating income, however, in the calculation of capital charge for operational risk, net interest income is gross of provisions.
In this example, net interest income is interest income minus interest expenses.
150 – 110 = 40
While for calculating net non-interest income for calculating operational risk capital charge, in this example:
Net non-interest income is fees and commissions received (80) minus fees and commissions paid, adjusted for outsourcing fees paid (50 – 12 = 38). Therefore, the amount will be 42.
2- Calculating operational risk capital charge under BIA
The following table shows how to calculate the operational risk capital charge under the BIA.
3- Treatment of Negative Gross Income
Below is the calculation of the operational risk capital charge when the bank has negative gross income for a year.
Amount Gross income year 1 -120 Gross income year 2 20 Gross income year 3 250 Total of positive gross income 270 Number of years with positive gross income 2 Average of positive annual gross income for the last three years 135 (270/2) Alpha 15% Operational risk capital requirement 20.25 (135*15%) Since negative gross income leads to exclusion of data points for that year from both the numerator and the denominator of the BIA operational risk formula, it could at times result in some distortions. For example, a bank that has negative gross income for one of three years might end up with a higher operational risk capital charge than if it were to have positive gross income for that year, even if it was a small amount. To ensure that such distortions do not occur, the supervisor should review and consider appropriate actions under Pillar 2.
B. Standardised Approach
1- Below is small example indicated which to include and exclude in the gross income:
Included Excluded Provisions Profits/losses from sale of securities Operating expenses Extraordinary/ irregular items Gross income for each business line should:
- -Be gross of any provisions (for example, for unpaid interest).
- -Be gross of operating expenses, including fees paid to outsourcing service providers.
- -Exclude realised profits/losses from the sale of securities in the banking book.
- -Exclude extraordinary or irregular items as well as income derived from insurance claims.
2- The following table shows how to calculate the capital charge for operational risk using the Standardised Approach:
Business line Beta factor Gross income Capital requirement Year 1 Year 2 Year 3 Year 1 Year 2* Year 3 Average Corporate finance 18% 250 300 200 45 54 36 Trading and sales 18% 100 -70 -80 18 -12.6 -14.4 Retail banking 12% 500 200 -300 60 24 -36 Commercial banking 15% 400 300 400 60 45 60 Payment and settlement 18% 300 350 300 54 63 54 Agency services 15% 75 50 45 11.25 7.5 6.75 Asset management 12% 50 -100 -20 6 -12 -2.4 Retail brokerage 12% 150 100 80 18 12 9.6 Total Gross Income 1,825 1,130 625 Aggregate Capital Requirement** 272.25 180.9 113.55 189*** *Gross Income x Beta factor
**Sum of eight capital charges for the year – remember within a year negative capital charges can offset positive charges among business lines
***Three-year average capital charge
3- Another example to illustrate the negative Gross income:
*Total capital charge against all business lines for year 2 is negative (-17.1), so the numerator for year 2 is set to zero
**Capital charge averaged for three years, with the numerator for year 2 set to zero
C. Alternative Standardised Approach
The following table shows how to calculate the capital charge for operational risk using the Alternative Standardised Approach.
Business line Beta factor Exposure Indicator* Capital requirement** Year 1 Year 2 Year 3 Year 1 Year 2 Year 3 Average Corporate finance 18% 250 300 200 45 54 36 Trading and sales 18% 100 -70 -80 18 -12.6 -14.4 Retail banking 12% 700*** 875*** 945*** 84 105 113.4 Commercial banking 15% 875*** 910*** 980*** 131.25 136.5 147 Payment and settlement 18% 300 350 300 54 63 54 Agency services 15% 75 50 45 11.25 7.5 6.75 Asset management 12% 50 -100 -20 6 -12 -2.4 Retail brokerage 12% 150 100 80 18 12 9.6 Total Gross Income 2,500 2,415 2,450 Aggregate Capital Requirement 367.5 353.4# 349.95 356.95## *Gross income/loans & advances x m
**Exposure indicator (GI or LA x m) x β
***Outstanding loans and advances x m (0.035)
# Sum of eight capital charges for the year
## Three year average capital charge