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Ready for new Op Risk RSA calculations under new Basel 3.1/Basel IV/CRR III & CRD VI*?

Under the current Basel-related regime (introduced in Basel II), to calculate the minimum capital requirements associated with operational risk the following approaches are permitted: Basic Indicator Approach (BIA), The Standardized Approach (TSA) & Alternative Standardized Approach (ASA), Advanced Measurement Approach (AMA; an internal model approach).

Under Basel 3.1/Basel IV/CRR III & CRD VI*, the Basel Committee on Banking Supervision (BCBS) introduced the new Revised Standardized Approach (RSA) for calculating the operational risk capital charge, which replaces all operational risk approaches allowed currently under Basel II.

The new Basel IV methodology is mostly commonly called the Revised Standardized Approach (RSA) for Operational Risk. It is also sometimes called the ‘Standardised Measurement Approach (SMA)’.
All firms are required to use this single RSA approach, which factors in historical operational risk losses as well as business indicator measures. No other methodologies are permitted under Basel 3.1/Basel IV/CRR III & CRD VI*.

The revised operational risk capital framework is based on two basic assumptions:

• Operational risk increases at an increasing rate with a bank’s income, and
• Banks with greater historical operational risk losses are more likely to experience operational risk losses in the future.

The veracity (accuracy) of these suppositions continues to be debated.
The new RSA for operational risk determines operational risk capital requirements based on the product (i.e., multiplication) of two components:

• “Business Indicator Component,” a progressive measure of a bank’s income (i.e., as a bank income increases, this component increases at a higher than proportionate rate). The BIC incorporates Business Indicators (BI) relating to various financial reporting, mainly income, measures; and
• “Internal Loss Multiplier,” a risk-sensitive component that reflects a bank’s historical internal losses. The ILM is based on historical operational loss experience relative to the BIC.

Therefore, there is positive and increasing (and progressive) synchronicity between the size of a bank and its operational risk capital calculated.
If you wish additional details or a walkthrough, please contact us.

In the next few articles, we'll continue to discuss issues related to the new capital requirements in further detail.

* Basel 3.1/Basel IV/CRR III & CRD VI/B3E/Finalised Basel III.

By: Mark Dougherty, Founder & Managing Director, RiskTAE (Risk Talent, Risk Advisory & Risk Education)
Email: mark.dougherty@risktae.com