# Operational Risk Capital Charge Calculation Methods– Basel – III

- Basic Indicator Approach (BIA): This is the approach most financial institutions start with.
- Standardized Approach (TSA): A more complex method.
- Advanced Measurement Approaches (AMA): The most sophisticated and sensitive to risk.
- Currently, financial institutions are required to use the Basic Indicator Approach.

## Basic Indicator Approach Explained:

- Capital for Operational Risk: This is calculated as an average of a fixed percentage of the institution’s positive annual gross income over the past three years. This fixed percentage is known as alpha (α), set at 15%.
- Formula: KBIA = [Sum (GI1…n x α)]/n, where KBIA is the capital charge, GI is the annual gross income (when positive), and n is the number of years with positive gross income in the past three years.

## Gross Income Definition and Components:

- Gross income includes net interest income plus net non-interest income.
- It should be:
- Before any provisions or write-offs.
- Exclusive of operating expenses and fees related to outsourcing.
- Excluding reversals from previous years, disposal income from property, profits/losses from “held to maturity” securities, income from legal settlements, and other extraordinary items.
- Not including income from insurance activities.

## Calculation Steps:

- Calculate the average of Gross Income multiplied by alpha (15%) for the last three years, excluding years with negative or zero gross income.
- Determine Gross Income by adding net profit, provisions, contingencies, operating expenses, and then subtracting specific excluded items.
- Apply the alpha value of 15%.

## Guidelines for Financial Institutions:

- While there are no specific criteria for using the Basic Indicator Approach, institutions should adhere to the Basel Committee’s guidance on managing operational risk and comply with risk management guidelines.
- After calculating the operational risk capital charge, this figure should be multiplied by 12.5 to arrive at the notional risk-weighted asset for operational risk.

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