Skip to main content

What are Minimum Capital Requirements for Operational Risk?

Reserve Bank of India (RBI) has released directions on minimum capital requirements for operational risk.

What is operational risk?

Operational risk means the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. 

This definition includes legal risk, but excludes strategic and reputational risk.

What is the objective of directions on minimum capital requirements for operational risk?

The directions require commercial banks to hold sufficient regulatory capital against its exposures arising from operational risk.

Which entities are covered under the directions?

The directions apply to all Commercial Banks (excluding Local Area Banks, Payments Banks, Regional Rural Banks, and Small Finance Banks).

What will be the changes in calculation of capital for operational risk?

The existing approaches for measuring minimum operational risk capital (ORC) requirements are as below –

  • Basic Indicator Approach (BIA)
  • Standardised Approach (TSA) / Alternative Standardised Approach (ASA) 
  • Advanced Measurement Approach (AMA).

All the existing approaches as mentioned above will be replaced by the new Standardised Approach (or Basel III Standardised Approach).

What are the components of Basel III Standardised Approach (Basel III SA)?

Basel III Standardised Approach (Basel III SA) calculation methodology is based on the following components –

  • Business Indicator (BI), which is a financial-statement-based proxy for operational risk. The constituents of BI include interest, lease and dividend, services and financial.
  • Business Indicator Component (BIC), which is calculated by multiplying the BI by a set of marginal coefficients (αi) (which increase with the size of the BI).
  • Internal Loss Multiplier (ILM), which is a scaling factor that is based on a bank’s average historical losses and the BIC.

The risk-weighted assets (RWA) for operational risk shall be calculated by multiplying the ORC by 12.5.

How shall ORC be calculated within a banking group? 

  • At the consolidated level, the ORC calculations shall be based on fully consolidated BI figures, which net all the intragroup income and expenses.
  • The ORC calculations at a sub-consolidated level shall be based on BI figures for the banks consolidated at that particular sub-level.
  • The ORC calculations at the subsidiary level shall be based on BI figures from the subsidiary.
  • A sub-consolidated bank or a subsidiary of the bank shall use only the losses it has incurred at that particular sub-consolidated or subsidiary level for the ORC calculations.

Which loss event shall be included in the loss data set?

RBI expects that a bank’s data collection and reporting procedures and processes capture all operational risk losses over the threshold of ₹1,00,000. 

However, if a bank excludes any eligible loss data event due to commission or omission errors or any other reason, it shall include such missed out data in the loss data set in the subsequent year by making necessary corrections for the relevant year. Such data shall be included in the loss data set from the year to which it pertains till 10 years from the year of detection of such missed out event.

What shall be the frequency of disclosures for operational risk?

Template Description of the template Frequency of disclosure
ORA General Qualitative information on a bank’s operational risk framework Annual
OR 1 Historical losses Annual
OR 2 Business Indicator and Sub components Quarterly
OR 3 Minimum required operational risk capital Quarterly

From when are the directions applicable?

The effective date of implementation of the directions will be separately communicated by RBI.


References

Reserve Bank of India. (2023, June 26). 'Master Direction on Minimum Capital Requirements for Operational Risk'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12520&Mode=0

Reserve Bank of India. (2023, June 26). 'Press Release - RBI releases ‘Master Direction on Minimum Capital Requirements for Operational Risk’'. Retrieved from https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=55922


Follow at - Telegram   Instagram   LinkedIn   Twitter   Facebook

Labels:

Comments

Post a Comment

Popular Posts

Reserve Bank of India Act, 1934 – Part-II – Section 17 to 19

The Reserve Bank of India Act, 1934 provides the statutory basis of the functioning of the Reserve Bank of India (RBI). In a series of articles, we will briefly go through the provisions of RBI Act, 1934. This is the second article in the series.  Section 17 – Business which the Bank may transact RBI shall be authorized to carry on and transact the several kinds of business hereinafter specified, namely – 17(1) – Accept deposit without interest from the Central / State Government, local authorities, banks and any other persons. 17(1A) – Accept deposit, repayable with interest, from banks or any other person under the Standing Deposit Facility Scheme, as approved by the Central Board, for the purposes of liquidity management.   Bills of Exchange (B/E) & Promissory Note (PN) Bearing 2 or more good signatures, one of which shall be of B/E & PN arising out of Maturing within 17(2)(a) Purchase, sale and rediscou...
Post a Comment
Read more

Reserve Bank of India Act, 1934 – Part-I – Preamble and Section 1 to 13

The Reserve Bank of India Act, 1934 provides the statutory basis of the functioning of the Reserve Bank of India (RBI). In a series of articles, we will briefly go through the provisions of RBI Act, 1934. This is the first article in the series. Preamble of the Act RBI to – Regulate the issue of bank notes. Keep reserves for monetary stability in India. Operate currency and credit system of the country to its advantage. The primary objective of the monetary policy is to maintain price stability while keeping in mind the objective of growth. Chapter I – Preliminary Section 1 – Short title, extent and commencement 1(1) – This Act may be called the Reserve Bank of India Act, 1934. 1(2) – The Act extends to whole of India. Chapter II - Incorporation, Capital, Management and Business Section 3 – Establishment and incorporation of Reserve Bank 3(1) – RBI to take over management of the currency from the Central Government. 3(2) – RBI to have perpetual succession, common seal, and shall by...
Post a Comment
Read more

Reserve Bank of India Act, 1934 – Part-III – Section 20 to 40

The Reserve Bank of India Act, 1934 provides the statutory basis of the functioning of the Reserve Bank of India (RBI). In a series of articles, we will briefly go through the provisions of RBI Act, 1934. This is the third article in the series.  Chapter III - Central Banking Functions Section 20 – Obligation of the Bank to transact Government business RBI shall undertake – To accept monies for account of the Central Government and to make payments up to the amount standing to the credit of its account, and to carry out its exchange, remittance and other banking operations. Management of the public debt of the Union. Section 21 – Bank to have the right to transact Government business in India The Central Government shall entrust RBI with – All its money, remittance, exchange and banking transactions in India, and shall deposit free of interest all its cash balances with RBI. The Central Government may carry on money transactions at places where RBI has no branches or agencies and m...
Post a Comment
Read more

Reserve Bank of India Act, 1934 – Part-IV – Section 42 to 45

The Reserve Bank of India Act, 1934 provides the statutory basis of the functioning of the Reserve Bank of India (RBI). In a series of articles, we will briefly go through the provisions of RBI Act, 1934. This is the fourth article in the series.  Section 42 – Cash reserves of scheduled banks to be kept with the Bank 42(1) – Every bank included in the Second Schedule shall maintain with RBI an average daily balance at a percent (notified by RBI) of its total demand and time liabilities in India. 42(1A) – RBI may direct every scheduled bank to maintain with RBI, in addition to the balance prescribed under Section 42(1), an additional average daily balance at a rate (specified by RBI). 42(1C) – RBI may specify any transaction or class of transactions to be regarded as liability in India of a scheduled bank. If any question arises as to whether any transaction or class of transactions shall be regarded as liability in India of a schedule bank, the decision of RBI thereon shall be fina...
Post a Comment
Read more

Reserve Bank of India Act, 1934 – Part-V – Section 45B to 45JA

The Reserve Bank of India Act, 1934 provides the statutory basis of the functioning of the Reserve Bank of India (RBI). In a series of articles, we will briefly go through the provisions of RBI Act, 1934. This is the fifth article in the series.  Chapter IIIA - Collection and Furnishing of Credit Information Section 45B – Power of Bank to collect credit information RBI may collect credit information from banking companies and furnish it to any banking company in accordance with section 45D. Section 45C – Power to call for returns containing credit information RBI may direct any banking company to submit statements relating to credit information. Section 45D – Procedure for furnishing credit information to banking companies A banking company may apply to RBI to provide credit information. RBI shall furnish the requested credit information without disclosing the names of the banking companies which have submitted the information. RBI may levy fees of up to Rs.25 for furnishing credit...
Post a Comment
Read more