20.The Standardised Approach (SA) represents a refinement along the continuum of approaches for calculating the operational risk capital charge. While this approach also relies on fixed factors as a percentage of gross income, it allows banks to use up to eight such factors, called betas, depending upon their business lines.

21.The calculation of the operational risk charge under this approach is more risk sensitive than the BIA.

The Standardised Approach Capital Charge

22.Under the Standardised Approach (SA), the operational risk capital charge is based on the operational risk capital charges for individual business lines in a bank. The formula for calculating the operational risk capital charge under the SA is as follows:

Where:

K_TSA = the capital charge under the Standardised Approach

GI_1-8 = the annual gross income in a given year, as defined in the Basic Indicator Approach (BIA), for each of the eight business lines

β _1-8 = a fixed percentage, set by the committee, relating the level of required capital to the level of the gross income for each of the eight business lines

The Standardised Approach Components

23.The Standardised Approach identifies two main components to be used in calculating the operational risk capital charge:

1.Gross Income of Eight Business Lines

24.Eight business lines are recommended for use by the Basel Committee in calculating the operational risk charge under the SA. These business lines are considered as being representative of the various kinds of businesses undertaken by banks. The identified business lines briefed below are:

1. 1.Corporate finance: banking arrangements and facilities provided to large commercial enterprises, multinational companies, non-bank financial institutions, government departments etc.
2. 2.Trading and sales: treasury operations, buying and selling of securities, currencies and commodities for proprietary and client accounts.
3. 3.Retail banking: financing arrangements for private individuals, retail clients and small businesses such as personal loans, credit cards, auto loans, etc. as well as other facilities such as trust and estates and investment advice.
4. 4.Commercial banking: financing arrangements for commercial enterprises, including project finance, real estate, trade finance, factoring, leasing, guarantees, bills of exchange etc.
5. 5.Payment and settlement: activities relating to payments and collections, interbank funds transfer, clearing and settlement.
6. 6.Agency services: acting as issuing and paying agents for corporate clients, providing custodial services etc.
7. 7.Asset management: managing funds of clients on a pooled, segregated, retail, institutional, open or closed basis under a mandate.
8. 8.Retail brokerage: broking services provided to customers that are retail investors rather than institutional investors.

25.Under the SA, the gross income is calculated for each of the eight business lines. It serves as a proxy for the likely scale of exposure of that business line of the bank to operational risk. Since all income has to be allocated to a business line, the sum of the gross income of the eight business lines should equal the gross income for the bank as a whole

26. Just like in the Basic Indicator Approach, gross income for SA comprises net interest income plus net non-interest income as defined in the Operational Risk section of the Standards re Capital Adequacy.

2.Beta

27.Beta serves as a proxy for the industry-wide relationship between the operational risk loss experience and the level of operational risk exposure as reflected in the gross income for a business line. It is representative of the amount of loss that can be incurred by a bank given that level of exposure (represented by gross income) in a business line.

28.The beta factors for the eight business lines as set by the Basel Committee are as follows:

29.The beta factors have been set within a range of 12-18% depending upon the degree of operational risk perceived in a business line. Thus, a 12% beta factor for retail banking indicates that, in general, the operational risk in retail banking is lower than the operational risk in commercial banking. The latter, which has a beta of 15%, carries a lower operational risk than, for example, payment and settlement, which carries a beta factor of 18%.

Treatment of Negative Gross Income from Business lines

30.Some banks may have negative gross income for some years in some business lines. This will result in a negative capital charge for the business line for that year. If the gross income and the resulting capital charge of a specific business line is negative, the aggregate of the capital charges across business lines for that year could still be positive, so long as the gross income from other business lines is positive.

31.The following guidance applies for treatment of negative capital charges under the Standardised Approach:

1. -In any given year, negative charges in business lines may offset positive capital charges in other business lines without any limit.
2. -If the total capital charge, after offsetting negative and positive capital charges of business lines, is negative for a given year, then the numerator for that year will be set to zero.
3. -If negative gross income distorts the operational risk capital charge calculated under the SA, the Central Bank will consider appropriate supervisory action under Pillar 2.

Calculating the Operational risk capital charge under the Standardised Approach (SA)

The calculation of the capital charge for operational risk under the SA follows the following steps:

Step 1: Calculate the capital charge for each business line using its gross income and applicable beta factor in year 1.

If the gross income from a business line is negative, the capital charge for that business line in year 1 will be negative.

Step 2: Sum the eight capital charges of business lines for Year 1.

In a year, negative capital charges in some business lines may offset positive capital charges for other business lines without any limit.

Steps 3 and 4: Follow steps 1 and 2 for the other two years.

Step 5: Calculate the 3-year average of the aggregated capital charges. Where the aggregate capital charge across all business lines in a given year is negative, then the input to the numerator for that year will be zero. The denominator will remain 3, representing the three years included in the calculation.

Central Bank supports the use of the Beta given in the Standards re Capital Adequacy as well as here in this guidance above as the basis for the capital calculations under SA.