4.Banks can apply one of two methods for calculating the Pillar 1 capital requirement for operational risk as below:

5.The Standardised Approach includes the Alternative Standardised Approach (ASA), which is a simplified version of the Standardised Approach that may be appropriate to small domestic banks focusing on retail or commercial banking activities.

6.Banks are encouraged to move from the BIA to SA as they develop more sophisticated operational risk measurement systems and practices. Qualifying criteria for the Standardised Approach are presented below in Section B.

7.Internationally active banks and banks with significant operational risk exposures (for example, specialised processing banks) are expected to use the SA.

8.The Central Bank will review the capital requirement produced by the operational risk approach used by a bank (whether BIA or SA) for general credibility, especially in relation to a bank’s peer. In the event that credibility is lacking, the Central Bank will consider appropriate supervisory action under Pillar 2.

9.A bank is required to use the same approach, either the BIA or the SA, for all parts of its operations. The use of SA is subject to qualification by the Central Bank on the basis of the qualification criteria outlined in Section B.

10.A bank using the SA is not allowed without supervisory approval to choose to revert to the BIA once it has been approved for the SA. However, if the Central Bank determines that a bank using SA no longer meets the qualifying criteria for this approach, it may require the bank to revert to the BIA.

1.The Basic Indicator Approach (BIA)

11.Banks using the BIA shall hold capital for operational risk equal to the average over the previous three years of a fixed percentage (denoted alpha) of positive annual gross income. Figures for any year in which annual gross income is negative or zero shall be excluded from both the numerator and denominator when calculating the gross income average.

12.The capital requirement shall be calculated as follows:

K_BIA = [∑(GI_1..n × α)]/n

2.The Standardised Approach (SA)

13.In the SA, banks’ activities are divided into eight business lines, including corporate finance, trading & sales, retail banking, commercial banking, payment & settlement, agency services, asset management, and retail brokerage. The business lines are defined in the table under Paragraph 12.

Principles for business line mapping:

14.The principles that banks shall apply for mapping their own business lines into the regulatory eight business lines as defined by the SA for the purpose of calculating the minimum capital required for operational risk are listed below.

Mapping of Business Lines
 

1. (i)All activities must be mapped into the eight level 1 business lines in a mutually exclusive and jointly exhaustive manner;
2. (ii)Any banking or non-banking activity which cannot be readily mapped into the business line framework, but which represents an ancillary function must be allocated to the business line it supports. If more than one business line is supported through the ancillary activity, an objective mapping criteria must be used;
3. (iii)When mapping gross income, if an activity cannot be mapped into a particular business line then the business line yielding the highest charge must be used. The same business line equally applies to any associated ancillary activity;
4. (iv)Banks may use internal pricing methods to allocate gross income between business lines provided that total gross income for the bank (as would be recorded under the BIA) still equals the sum of gross income for the eight business lines;
5. (v)The mapping of activities into business lines for operational risk capital purposes must be consistent with the definitions of business lines used for regulatory capital calculations in other risk categories (i.e., credit and market risk). Any deviations from this principle must be clearly motivated and documented;
6. (vi)The mapping process used must be clearly documented. In particular, written business line definitions must be clear and detailed enough to allow third parties to replicate the business line mapping. Documentation must, among other things, clearly motivate any exceptions or overrides and be kept on record;
7. (vii)Processes must be in place to define the mapping of any new activities or products;
8. (viii)Senior management is responsible for the mapping policy (which is subject to the approval by the board of directors); and
9. (ix)The mapping process to business lines must be subject to independent review.

Supplementary business line mapping guidance:

15.There is a variety of valid approaches that banks may use to map their activities to the eight business lines, provided the approach used meets the business line mapping principles set out above. The following is therefore an example of one possible approach that could be used by a bank to map its gross income and it is hereby presented for guidance only.

1. (i)Gross income for retail banking consists of net interest income on loans and advances to retail customers and SMEs treated as retail, plus fees related to traditional retail activities, net income from swaps and derivatives held to hedge the retail banking book, and income on purchased retail receivables. To calculate net interest income for retail banking, a bank takes the interest earned on its loans and advances to retail customers less the weighted average cost of funding of the loans (from whatever source — retail or other deposits).
2. (ii)Similarly, gross income for commercial banking consists of the net interest income on loans and advances to corporate (plus SMEs treated as corporate), interbank and sovereign customers and income on purchased corporate receivables, plus fees related to traditional commercial banking activities including commitments, guarantees, bills of exchange, net income (e.g., from coupons and dividends) on securities held in the banking book, and profits/losses on swaps and derivatives held to hedge the commercial banking book. The calculation of net interest income is based on interest earned on loans and advances to corporate, interbank and sovereign customers less the weighted average cost of funding for these loans (from whatever source).
3. (iii)For trading and sales, gross income consists of profits/losses on instruments held for trading purposes (i.e., in the mark-to-market book), net of funding cost, plus fees from wholesale brokerage.
4. (iv)For the other five business lines, gross income consists primarily of the net fees/commissions earned in each of these businesses. Payment and settlement consists of fees to cover provision of payment/settlement facilities for wholesale counterparties. Payment and settlement losses related to bank’s own activities should also be incorporated in the loss experience of the affected business line. Asset management is management of assets on behalf of others.

Capital Calculation under the Standardised Approach:

16.Within each business line, gross income is a broad indicator that serves as a proxy for the scale of business operations and thus the likely scale of operational risk exposure within each of these business lines. The capital charge for each business line is calculated by multiplying gross income by a factor (denoted by beta) assigned to that business line. Beta serves as a proxy for the industry-wide relationship between the operational risk loss experience for a given business line and the aggregate level of gross income for that business line. It should be noted that in the SA gross income is measured for each business line, not the whole institution, (e.g., in corporate finance, the indicator is the gross income generated in the corporate finance business line).

17.The total capital charge is calculated as the three-year average of the simple summation of the regulatory capital charges across each of the business lines in each year. In any given year, negative capital charges (resulting from negative gross income) in any business line may offset positive capital charges in other business lines without limit. However, where the aggregate capital charge across all business lines within a given year is negative, then the input to the numerator for that year shall be zero. The total capital charge may be expressed as:

Capital Calculation under the Alternative Standardised Approach:

18.The Central Bank may allow a bank to use the ASA provided the bank is able to satisfy the Central Bank that this alternative approach provides an improved basis for capturing its operational risk. Once a bank has been allowed to use the ASA, it will not be allowed to revert to use of the SA without the permission of the Central Bank. Large diversified banks in major markets are not authorized to use the ASA.

19.Under the ASA, the operational risk capital charge and methodology are the same as for the SA except for two business lines — retail banking and commercial banking. For these business lines, loans and advances — multiplied by a fixed factor ‘m’ — replaces grossincome as the exposure indicator. The betas for retail and commercial banking are unchanged from the SA. The ASA operational risk capital charge for retail banking (with the same basic formula for commercial banking) can be expressed as:

K_RB = β_RB × m × LA_RB

20.For the purposes of the ASA, total loans and advances in the retail banking business line consists of the total drawn amounts in the following credit portfolios: retail, SMEs treated as retail, and purchased retail receivables.

21.For commercial banking, total loans and advances consists of the drawn amounts in the following credit portfolios: corporate, sovereign, bank, specialised lending, SMEs treated as corporate and purchased corporate receivables. The book value of securities held in the banking book should also be included.

22.Under the ASA, banks may aggregate retail and commercial banking (if they wish to) using a beta of 15%.

23.Similarly, those banks that are unable to disaggregate their gross income into the other six business lines can aggregate the total gross income for these six business lines using a beta of 18%, with negative gross income treated as described in paragraph 15 above.

24.As under the SA, the total capital charge for the ASA is calculated as the simple summation of the regulatory capital charges across each of the eight business lines.