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P2.T7.402. Operational risk approaches under Basel III

Nicole Seaman

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Describe and contrast the major elements of the three options available for the calculation of operational risk: Basic Indicator Approach; Standardized Approach; Advanced Measurement Approach

Questions:

402.1. Each of the following is true about the Basic Indicator Approach (BIA) to operational risk under Basel III EXCEPT which is false?

a. Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events
b. The definition of operational risk includes strategic and reputational risk, but excludes legal risk
c. Banks using the Basic Indicator Approach (BIA) must hold capital for operational risk equal to the average over the previous three years of a fixed percentage (denoted alpha) of positive annual gross income.
d. Under the Basic Indicator Approach (BIA), Gross Income is defined as net interest income plus net non-interest income


402.2. Each of the following is true about the Standardized Approach (SA) to operational risk under Basel III EXCEPT which is false?

a. Whereas the Basic Indicator Approach (BIA) uses Gross Income for the whole institution as a proxy for the scale of business operations, the standardized approach (SA) calculates the capital charge for each business line by multiplying its gross income by a factor (denoted beta) assigned to that business line
b. The beta factor in the Standardized Approach (SA) 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
c. Under the standardized approach (SA), business units that fail to provision expected operational losses must calibrate their risk charge based on the unexpected loss at 99.99% confidence level (i.e., rather than 99.9%) over a one-year horizon
d. A national supervisor can allow a bank to use the Alternative Standardized Approach (ASA) which replaces gross income with loans and advances for retail and commercial banking business lines


402.3. Each of the following is true about the Advanced Measurement Approach (AMA) to operational risk under Basel III EXCEPT which is false?

a. Under the AMA, a bank must develop specific policies and have documented criteria for mapping gross income for current business lines and activities into the AMA framework.
b. Under the AMA, a bank can use its own internal model(s) but the quantitative standards include a charge for unexpected losses at 99.9% confidence over one-year horizon
c. To qualify for the AMA, the bank must have an independent operational risk management function that is responsible for the design and implementation of the bank’s operational risk management framework
d. To qualify for the AMA, the bank must: use internal loss data; use external loss data; use scenario analysis; and take into account key business environment and internal control
factors

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