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Basel II has been in the news an awful lot these past 18 month or so. Unlike Basel I the new standard introduces a capital charge based on operational risk. The words Operational risk themselves immediately raise a whole bunch of questions; What is Basel II? What is operational risk? How is the charge going to be calculated? What are the operational risk standards that banks will have to comply with? Basel II or to use is full name International Convergence of Capital Measurement and Capital Standards defines operational risk as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition explicitly includes legal risk but excludes strategic and reputational risk. In terms of the Basel II Accord there are three methods for calculating the capital charges for operational risk. The methods provide a range of increasing sophistication and risk sensitivity. The three approaches are:
- Basic Indicator Approach (BIA) which requires banks to hold capital for operational risk equal to the average over the previous three years of a fixed percentage of positive annual gross income.
- Standardized Approach which uses gross income across eight business lines as a stand-in for the level of business operations and therefore the probable size of operational risk exposure within each business line.
- Advanced Measurement Approaches (AMA) this requires a bank to calculate its regulatory capital requirement as the sum of expected loss and unexpected loss. This is a highly complicated process and still remains the subject of much controversy.
- All operational risks of the banks global, consolidated operations must be captured
- All of the banks operations that are covered by the Advanced Measurement Approaches must meet the qualitative criteria for using an AMA, while those parts of its operations that are using one of the simpler approaches meet the qualifying criteria for that approach
- At implementation of an AMA, a major part of the banks operational risks must be captured by the AMA
- The bank must provide its supervisor with a plan specifying its intended timetable for implementing the AMA across all its operations
- Sound Practices for the Management and Supervision of Operational Risk
- A framework for Internal Control Systems in Banking Organizations
- Internal Audits in Banks and the Supervisors Relationship with Auditors
- The compliance function in banks
- Consolidated KYC Risk Management
- Risk management principles for electronic banking
- Management and Supervision of Cross-Border Electronic Banking Activities.