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please explain how Basic indicator approach helps mitigate operational risk

please explain how Basic indicator approach helps mitigate operational risk

Foundations of Business (MindTap Course List)
Foundations of Business (MindTap Course List)
6th Edition
ISBN:9781337386920
Author:William M. Pride, Robert J. Hughes, Jack R. Kapoor
Publisher:William M. Pride, Robert J. Hughes, Jack R. Kapoor
Chapter15: Using Management And Accounting Information
Section: Chapter Questions
Problem 6DQ
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please explain how Basic indicator approach helps mitigate operational risk

Approach #1: Basic Indicator Approach The basic indicator approach is one of the earliest approaches which was recommended by the Bank of International Settlements in its Basel norms. Compared to the current method, it seems like a crude back-of-the-envelope calculation today. However, it is still widely useful for banks that do not have a significant international presence. The purpose of the basic indicator approach is to help the banks calculate the amount of capital that they need to set aside to meet operational risk requirements. This is done in three steps. Step 1: Calculate a fixed percentage known as alpha. In most parts of the world, this number is 15%. Step 2: Calculate the positive gross income over the past three-year period. It is important to note the emphasis on the word positive. If the income is less than zero, then it should be excluded both from the numerator and denominator. Also, extraordinary one-time incomes, as well as expenses, should be excluded from the calculation. The positive gross income for the past three years needs to be averaged in order to arrive at a number. Step 3: Multiple the alpha with the average gross income over the past three years to derive the amount of capital that needs to be set aside for risk management purposes.
Transcribed Image Text:Approach #1: Basic Indicator Approach The basic indicator approach is one of the earliest approaches which was recommended by the Bank of International Settlements in its Basel norms. Compared to the current method, it seems like a crude back-of-the-envelope calculation today. However, it is still widely useful for banks that do not have a significant international presence. The purpose of the basic indicator approach is to help the banks calculate the amount of capital that they need to set aside to meet operational risk requirements. This is done in three steps. Step 1: Calculate a fixed percentage known as alpha. In most parts of the world, this number is 15%. Step 2: Calculate the positive gross income over the past three-year period. It is important to note the emphasis on the word positive. If the income is less than zero, then it should be excluded both from the numerator and denominator. Also, extraordinary one-time incomes, as well as expenses, should be excluded from the calculation. The positive gross income for the past three years needs to be averaged in order to arrive at a number. Step 3: Multiple the alpha with the average gross income over the past three years to derive the amount of capital that needs to be set aside for risk management purposes.
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