9.The Basic Indicator Approach (BIA) is a simple approach for calculating the capital charge for operational risk. It can be used by banks that are not internationally active, as well as by banks that are internationally active but may not yet have risk management systems in place for using the more advanced approaches for measuring operational risk.

10.While the approach is available for all banks as a 'point of entry', irrespective of their level of sophistication, Central Bank expects internationally active banks and banks with significant operational risk to discontinue indefinitely with the Basic Indicator Approach.

The Basic Indicator Approach Components

11.The operational risk capital charge under the BIA is based on two components:

1. 1.The exposure indicator, represented by the Gross Income (GI) of a bank as a whole.
2. 2.The fixed factor, alpha (α), set by the Basel Committee.

The formula for calculating the capital charge for operational risk under the BIA is as follows:

Where:

K_BIA = The capital charge under the BIA;

GI = Annual gross income, where positive, over the previous three years;

n = Number of the previous three years for which gross income is positive; and

α =15%, relating the industry wide level of required capital to the industry wide level of the indicator.

1.Gross Income of the Bank

12.Gross income is a broad indicator that serves as a proxy for the likely exposure of a bank to operational risk. It is the total of net interest income plus net non-interest income of a bank as a whole. Net interest income is defined as interest income of a bank (for example, from loans and advances) minus the interest expenses (for example, interest paid on deposits). Net non-interest income is defined as fees and commissions earned minus the non-interest expenses (that is, fees and commissions paid) and other income.

13.Gross income used in the calculation of the capital charge for operational risk should be:

1. -Gross of any provisions, for example, for unpaid interest. This is because such amounts should have normally formed part of a bank's income but have been set aside for likely credit losses.
2. -Gross of operating expenses, including fees paid to outsourcing service providers. This is because outsourcing of activities does not fully transfer operational risk to the service provider. Outsourcing is the strategic use of outside resources to perform business functions that are traditionally managed by internal staff. Outsourcing offers the advantage of access to specialised and experienced personnel that may not be available internally, and enables banks to concentrate on their core business and reduce costs.

14.Only sustainable, renewable and recurrent sources of income are to be used as the basis for calculating the operational risk capital charge. Banks should perform a reconciliation between the gross income reported on the capital adequacy return and the audited financial statements. This information should be available to the Central Bank upon request. As such, gross income should exclude:

1. -realised profits/losses from the sale of securities classified as 'held to maturity' and 'available for sale', which typically constitute items of the banking book under certain accounting standards. The intention is to hold such securities for some time or up to their full term and not for trading purposes. Their sale does not represent sustainable income from normal business.
2. -Held to maturity securities are those that the bank intends to hold indefinitely or until the security reaches its maturity. Available for sale securities includes securities that are neither held for trading purposes nor intended to be held till maturity. These are securities that the bank intends to hold in the short or medium term, but may ultimately sell. Banking book relates to positions that are held to maturity with no trading intent associated with them. Most loans and advances are included in the banking book as they are intended to be held until maturity. At times, there may also be liquid positions assigned to the banking book if they are intended to be held over a longer term or to maturity.
3. -Extraordinary or irregular items as well as income derived from insurance claims. Again, these items are to be excluded, as they are not sustainable sources of income for a bank.

15.Banks sometimes outsource certain activities, such as processing and maintaining data on loan collection services to external service providers. Alternatively, banks may act as service providers to other banks. This results in the payment or receipt of a fee for the outsourced service.

16.Basel provides the following guidance for the treatment of outsourcing fees paid or received, while calculating the gross income for the purpose of calculating the operational risk capital charge:

1. -Outsourcing fees paid by a bank to a service provider do not reduce the gross income of the bank.
2. -Outsourcing fees received by a bank for providing outsourcing services are included in the definition of gross income.

2.Alpha

17.Alpha is a fixed factor, set by the Basel Committee. It serves as a proxy for the industry-wide relationship between operational risk loss experience of a bank and the aggregate level of the operational risk exposure as reflected in its gross income.

Treatment of Negative Gross Income

18.The operational risk capital charge under the BIA is assumed that a bank has positive gross income for all of the previous three years. However, some banks may have negative gross income for some year(s), for example, resulting from poor financial performance. Figures for any year in which annual gross income is negative or zero shall be excluded from both the numerator and denominator when calculating the gross income average.

19.On this basis, the figures presented in the 3 years' calculations should reconcile (or be reconcilable) with the bank’s audited financial statements.