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Approaches for Determining Operational Risk

There are three main approaches for calculating operational risk capital requirement:

  • The basic indicator approach
    • In this approach, operational risk capital is based on 15% of the bank’s annual gross income over the period of 3 years
    • Includes both interest and non interest income
  • The standardized approach
    • In this approach, bank uses eight business lines with different beta factors to calculate the capital requirement
    • Beta factor for each business line is multiplied with the annual gross income of the business line over the period of 3 years
    • The results are then added to arrive at total operational risk capital charge
  • The advanced measurement approach (AMA)
    • Large banks are encouraged to move from standardized approach to AMA because with AMA, banks can reduce their capital requirement by investing in risk management infrastructure.


Advanced Measurement Approach



The operational risk capital requirement currently proposed by the Basel Committee is equal to the unexpected loss in a total loss distribution that corresponds to the confidence level of 99.9% over a 1 year time horizon

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