Definitions and application
This chapter defines operational risk and the components of the Business Indicator used to calculate capital requirements for operational risk. In addition, this chapter describes the application within a banking group of the standardised approach for measuring operational risk capital requirements.
- Effective as of: 01 Jan 2023
- Last update: 05 Jul 2024
- Status Current
Definition of operational risk
10.1
Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk,1 but excludes strategic and reputational risk.
1 Footnote
| 1 | Legal risk includes, but is not limited to, exposure to fines, penalties, or punitive damages resulting from supervisory actions, as well as private settlements. |
Definition of Business Indicator components
10.2
Table 1 defines the components of the Business Indicator (BI).
|
Business Indicator definitions |
Table 1 |
|||
|
BI component |
Income statement or balance sheet items |
Description |
Typical sub-items |
|
|
Interest, lease and dividend |
Interest income |
Interest income from all financial assets and other interest income (includes interest income from financial and operating leases and profits from leased assets) |
|
|
|
Interest expenses |
Interest expenses from all financial liabilities and other interest expenses (includes interest expense from financial and operating leases, depreciation and impairment of, and losses from, operating leased assets) |
|
||
|
Interest earning assets (balance sheet item) |
Total gross outstanding loans, advances, interest bearing securities (including government bonds), and lease assets measured at the end of each financial year |
|||
|
Dividend income |
Dividend income from investments in stocks and funds not consolidated in the bank's financial statements, including dividend income from non-consolidated subsidiaries, associates and joint ventures. |
|||
|
Services |
Fee and commission income |
Income received from providing advice and services. Includes income received by the bank as an outsourcer of financial services. |
Fee and commission income from:
|
|
|
Fee and commission expenses |
Expenses paid for receiving advice and services. Includes outsourcing fees paid by the bank for the supply of financial services, but not outsourcing fees paid for the supply of non-financial services (eg logistical, IT, human resources) |
Fee and commission expenses from:
|
||
|
Other operating income |
Income from ordinary banking operations not included in other BI items but of similar nature (income from operating leases should be excluded) |
|
||
|
Other operating expenses |
Expenses and losses from ordinary banking operations not included in other BI items but of similar nature and from operational loss events (expenses from operating leases should be excluded) |
|
||
|
Financial |
Net profit (loss) on the trading book |
|
||
|
Net profit (loss) on the banking book |
|
|||
2 FAQs
| FAQ1 | Should credit obligations on non-accrued status (eg non-performing loans) be classified as interest-earning assets for purposes of the calculation of Interest, Leases, and Dividend Component of the BI? Yes. All outstanding credit obligations in the balance sheet, including credit obligations on non-accrued status (eg non-performing loans), should be included in interest-earning assets for the purposes of the calculation of Interest, Leases, and Dividend Component of the BI. |
| FAQ2 | When should derivative assets be included in interest earning assets? The interest rate derivative assets that, depending on the accounting treatment under the applicable accounting standard, affect a bank’s interest income (as included in the interest, leases and dividend component of the business indicator) should be included in interest earning assets used in the calculation of the interest, leases and dividend component. These derivative assets should be captured at their fair value (not their notional value). The fair value used must be positive. A negative fair value should not be subtracted. |
10.3
The following profit and loss items do not contribute to any of the items of the BI:
- Income and expenses from insurance or reinsurance businesses.
- Premiums paid and reimbursements/payments received from insurance or reinsurance policies purchased.
- Administrative expenses, including staff expenses, outsourcing fees paid for the supply of non-financial services (eg logistical, human resources, information technology – IT), and other administrative expenses (eg IT, utilities, telephone, travel, office supplies, postage).
- Recovery of administrative expenses including recovery of payments on behalf of customers (eg taxes debited to customers).
- Expenses of premises and fixed assets (except when these expenses result from operational loss events).
- Depreciation/amortisation of tangible and intangible assets (except depreciation related to operating lease assets, which should be included in financial and operating lease expenses).
- Provisions/reversal of provisions (eg on pensions, commitments and guarantees given) except for provisions related to operational loss events.
- Expenses due to share capital repayable on demand.
- Impairment/reversal of impairment (eg on financial assets, non-financial assets, investments in subsidiaries, joint ventures and associates).
- Changes in goodwill recognised in profit or loss.
- Corporate income tax (tax based on profits including current tax and deferred).
1 FAQ
| FAQ1 | Should income and expenses from insurance activities where the bank acts as an intermediary (rather than the insurance provider) be excluded from the Business Indicator? No. When the bank acts as an insurance intermediary and, therefore, is not the insurance provider (ie the risk taker), the related income and expenses are not excluded from the Business Indicator. On the other hand, income and expenses from the bank’s insurance or reinsurance business (ie relating to activities where a bank acts as the insurance provider) are excluded. |
Application of the standardised approach within a banking group
10.4
At the consolidated level, the standardised approach calculations use fully consolidated BI figures, which net all the intragroup income and expenses. The calculations at a sub-consolidated level use BI figures for the banks consolidated at that particular sub-level. The calculations at the subsidiary level use the BI figures from the subsidiary.
10.5
Similar to bank holding companies, when BI figures for sub-consolidated or subsidiary banks reach bucket 2, these banks are required to use loss experience in the standardised approach calculations. A sub-consolidated bank or a subsidiary bank uses only the losses it has incurred in the standardised approach calculations (and does not include losses incurred by other parts of the bank holding company).
10.6
In case a subsidiary of a bank belonging to bucket 2 or higher does not meet the qualitative standards for the use of the Loss Component, this subsidiary must calculate the standardised approach capital requirements by applying 100% of the BI Component. In such cases supervisors may require the subsidiary to apply an internal loss multiplier which is greater than 1.
This standard describes the scope of application of the Basel Framework.
This standard describes the criteria that bank capital instruments must meet to be eligible to satisfy the Basel capital requirements, as well as necessary regulatory adjustments and transitional arrangements.
This standard describes the framework for risk-based capital requirements.
This standard describes how to calculate capital requirements for credit risk.
This standard describes how to calculate capital requirements for market risk and credit valuation adjustment risk.
This standard describes how to calculate capital requirements for operational risk.
This standard describes the simple, transparent, non-risk-based leverage ratio. This measure intends to restrict the build-up of leverage in the banking sector and reinforce the risk-based requirements with a simple, non-risk-based "backstop" measure.
This standard describes the Liquidity Coverage Ratio, a measure which promotes the short-term resilience of a bank's liquidity risk profile.
The net stable funding ratio requires banks to maintain a stable funding profile in relation to the composition of their assets and off-balance-sheet activities.
Large exposures regulation limits the maximum loss that a bank could face in the event of a sudden counterparty failure to a level that does not endanger the bank's solvency. This standard requires banks to measure their exposures to a single counterparty or a group of connected counterparties and limit the size of large exposures in relation to their capital.
This standard establishes minimum standards for margin requirements for non-centrally cleared derivatives. Such requirements reduce systemic risk with respect to non-standardised derivatives by reducing contagion and spillover risks and promoting central clearing.
The Pillar 2 supervisory review process ensures that banks have adequate capital and liquidity to support all the risks in their business, especially with respect to risks not fully captured by the Pillar 1 process, and encourages good risk management.
This standard sets out disclosure requirements, which aim to encourage market discipline.
The Basel Core Principles provide a comprehensive standard for establishing a sound foundation for the regulation, supervision, governance and risk management of the banking sector.
