Capital Charge for Operational Risk

Capital Charge for Operational Risk

  • The capital charge for operational risk is the amount of capital that a bank must hold to cover its exposure to operational risk.
  • Operational risk is the risk of losses arising from inadequate or failed internal processes, people and systems or from external events.
  • The capital charge for operational risk is calculated using a variety of factors, including the bank’s business model, its risk appetite, and its internal controls.

MCQs

  1. What is the capital charge for operational risk?
    • The amount of capital that a bank must hold to cover its exposure to operational risk.
  2. What is operational risk?
    • The risk of losses arising from inadequate or failed internal processes, people and systems or from external events.
  3. What are the factors that are used to calculate the capital charge for operational risk?
    • The bank’s business model, its risk appetite, and its internal controls.
  4. What is the standardized approach to calculating the capital charge for operational risk?
    • A simple approach that uses a fixed percentage of the bank’s annual revenue to calculate capital requirements.
  5. What is the advanced measurement approach to calculating the capital charge for operational risk?
    • A more sophisticated approach that allows banks to use their own models to calculate capital requirements.

Answers

  1. The amount of capital that a bank must hold to cover its exposure to operational risk.
  2. The risk of losses arising from inadequate or failed internal processes, people and systems or from external events.
  3. The bank’s business model, its risk appetite, and its internal controls.
  4. A simple approach that uses a fixed percentage of the bank’s annual revenue to calculate capital requirements.
  5. A more sophisticated approach that allows banks to use their own models to calculate capital requirements.

Benefits of the capital charge for operational risk

  • The capital charge for operational risk helps to ensure that banks have sufficient capital to absorb losses from operational incidents.
  • It also helps to discourage banks from taking on excessive risk.
  • The capital charge for operational risk can also help to promote financial stability by reducing the risk of bank failures.

Criticisms of the capital charge for operational risk

  • The capital charge for operational risk has been criticized for being too simplistic and for not taking into account all of the risks that banks face.
  • For example, the capital charge for operational risk does not take into account the risk of correlation between operational incidents.
  • As a result, the capital charge for operational risk may not be sufficient to protect banks from large losses.

Overall, the capital charge for operational risk is an important tool for managing operational risk in the banking industry. However, it is still a work in progress and there is room for improvement.

Here are some additional details about the standardized approach and the advanced measurement approach to calculating the capital charge for operational risk:

  • Standardized approach: The standardized approach uses a fixed percentage of the bank’s annual revenue to calculate capital requirements. The percentage is based on the bank’s business model and its risk appetite. For example, banks with a high risk appetite are required to hold a higher percentage of capital against operational risk than banks with a low risk appetite.
  • Advanced measurement approach: The advanced measurement approach allows banks to use their own models to calculate capital requirements. Banks must first develop their own operational risk models, which are then subject to review by their regulators. The models must be able to accurately assess the risk of operational losses for different types of businesses.

The standardized approach is simpler to implement than the advanced measurement approach. However, the standardized approach is also less accurate, as it does not take into account all of the factors that can affect operational risk. The advanced measurement approach is more accurate, but it is also more complex and more difficult to implement.

The Basel Committee on Banking Supervision (BCBS) is currently working on a new approach to calculating the capital charge for operational risk. The new approach, known as the revised operational risk framework (RORF), is expected to be finalized in 2023. The RORF is expected to be more accurate and more risk-sensitive than the current RORF.