Standardized approach (operational risk)
Encyclopedia
In the context of operational risk
, the standardized approach or standardised approach is a set of operational risk measurement techniques proposed under Basel II
capital adequacy rules for banking institutions.
Basel II requires all banking institutions to set aside capital for operational risk
. Standardized approach falls between basic indicator approach
and advanced measurement approach
in terms of degree of complexity.
Based on the original Basel Accord
, under the Standardised Approach, banks’ activities are divided into eight business lines: corporate finance
, trading & sales, retail banking
, commercial banking, payment & settlement, agency services, asset management, and retail brokerage. Within each business line, gross income is a broad indicator that serves as a proxy for the scale of business operations and thus the likely scale of operational risk exposure within each of these business lines. The capital charge for each business line is calculated by multiplying gross income
by a factor (denoted beta) assigned to that business line. Beta serves as a proxy for the industry-wide relationship between the operational risk loss experience for a given business line and the aggregate level of gross income for that
business line.
The total capital charge is calculated as the three-year average of the simple summation of the regulatory capital charges across each of the business lines in each year. In any given year, negative capital charges (resulting from negative gross income) in any business line may offset positive capital charges in other business lines without limit.
In order to qualify for use of the standardised approach, a bank must satisfy its regulator that, at a minimum:
Operational risk
An operational risk is, as the name suggests, a risk arising from execution of a company's business functions. It is a very broad concept which focuses on the risks arising from the people, systems and processes through which a company operates...
, the standardized approach or standardised approach is a set of operational risk measurement techniques proposed under Basel II
Basel II
Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision...
capital adequacy rules for banking institutions.
Basel II requires all banking institutions to set aside capital for operational risk
Operational risk
An operational risk is, as the name suggests, a risk arising from execution of a company's business functions. It is a very broad concept which focuses on the risks arising from the people, systems and processes through which a company operates...
. Standardized approach falls between basic indicator approach
Basic indicator approach
The basic approach or basic indicator approach is a set of operational risk measurement techniques proposed under Basel II capital adequacy rules for banking institutions....
and advanced measurement approach
Advanced measurement approach
Under Basel II, operational risk charges can be calculated by using one of the three methods that increase in sophistication and risk sensitivity: the Basic Indicator Approach; the Standardised Approach; and Advanced Measurement Approaches .Under AMA the banks are allowed to develop their own...
in terms of degree of complexity.
Based on the original Basel Accord
Basel Accord
The Basel Accords refer to the banking supervision Accords —Basel I and Basel II issued and Basel III—by the Basel Committee on Banking Supervision ....
, under the Standardised Approach, banks’ activities are divided into eight business lines: corporate finance
Corporate finance
Corporate finance is the area of finance dealing with monetary decisions that business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize shareholder value while managing the firm's financial risks...
, trading & sales, retail banking
Retail banking
Retail banking is banking in which banking institutions execute transactions directly with consumers, rather than corporations or other banks. Services offered include: savings and transactional accounts, mortgages, personal loans, debit cards, credit cards, and so forth.-Types of...
, commercial banking, payment & settlement, agency services, asset management, and retail brokerage. Within each business line, gross income is a broad indicator that serves as a proxy for the scale of business operations and thus the likely scale of operational risk exposure within each of these business lines. The capital charge for each business line is calculated by multiplying gross income
Gross income
Gross income in United States tax law is receipts and gains from all sources less cost of goods sold. Gross income is the starting point for determining Federal and state income tax of individuals, corporations, estates and trusts, whether resident or nonresident."Except as otherwise provided" by...
by a factor (denoted beta) assigned to that business line. Beta serves as a proxy for the industry-wide relationship between the operational risk loss experience for a given business line and the aggregate level of gross income for that
business line.
| Business Line | Beta Factor |
|---|---|
| Corporate finance | 18% |
| Trading and sales | 18% |
| Retail banking | 12% |
| Commercial banking | 15% |
| Payment and settlement | 18% |
| Agency services | 15% |
| Asset Management | 12% |
| Retail Brokerage | 12% |
The total capital charge is calculated as the three-year average of the simple summation of the regulatory capital charges across each of the business lines in each year. In any given year, negative capital charges (resulting from negative gross income) in any business line may offset positive capital charges in other business lines without limit.
In order to qualify for use of the standardised approach, a bank must satisfy its regulator that, at a minimum:
- Its board of directors and senior management, as appropriate, are actively involved in the oversight of the operational risk management framework;
- It has an operational risk management system that is conceptually sound and is implemented with integrity; and
- It has sufficient resources in the use of the approach in the major business lines as well as the control and audit areas.
See also
- Basic indicator approachBasic indicator approachThe basic approach or basic indicator approach is a set of operational risk measurement techniques proposed under Basel II capital adequacy rules for banking institutions....
- Advanced measurement approachAdvanced measurement approachUnder Basel II, operational risk charges can be calculated by using one of the three methods that increase in sophistication and risk sensitivity: the Basic Indicator Approach; the Standardised Approach; and Advanced Measurement Approaches .Under AMA the banks are allowed to develop their own...
- Operational riskOperational riskAn operational risk is, as the name suggests, a risk arising from execution of a company's business functions. It is a very broad concept which focuses on the risks arising from the people, systems and processes through which a company operates...
- Capital Requirements DirectiveCapital Requirements DirectiveThe Capital Requirements Directive for the financial services industry will introduce a supervisory framework in the EU which reflects the Basel II rules on capital measurement and capital standards....
- Basel IIBasel IIBasel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision...