1. Operational Risk Chapter XX

2. What Is Operational Risk? Operational risk is the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events. This definition includes legal risk but does not include business risk such as reputation risk and strategic risk.

3. Determination of Regulatory Capital Banks have three approaches in determining operational risk regulatory capital. The simplest approach is the basic indicator approach where operational risk is set equal to 15% of annual gross income (net interest income plus noninterest income) over the previous three years.

4. Determination of Regulatory Capital Another approach is the standardized approach that divides bank’s activities into eight business lines. The average gross income over the last three years for each business line is multiplied by a “beta factor” for that business line and the result summed to determine the total capital.

5. Determination of Regulatory Capital Business lineBeta factor Corporate finance18% Trading and sales18% Retail banking12% Commercial banking15% Payment and settlement18% Agency services15% Asset management12% Retail brokerage12%

6. Determination of Regulatory Capital The last approach is the advanced measurement approach (AMA) in which operational risk regulatory capital requirement is calculated by the bank internally using qualitative and quantitative criteria.