In this article, we are going to explain the different approaches to measure operational risk in an organization. See what they are!
According to Basel Committee on Banking Supervision, there is a basic indicator approach (BIA), standard measure, and advanced measurement techniques for operational safety of banking institutions. Today we will talk about each type separately so that you can make better decisions when it comes time for your company’s next assessment.
Basic indicator approach for measuring operational risk
The basic indicator approach is a simple way to measure operational risk for small financial entities. It calculates the percentage of gross income over three years and then divides it by what was earned during those same periods last time around; this provides an easy-to-compare figure between now versus before!
The standard approach to measuring operational risk (SA)
According to this method to measure operating risk, banks’ activities are divided into eight lines of business. These eight lines of business are corporate finance, commercial banking, sales and trading, retail banking, payments and settlements, asset management agency services, and retail brokerage.
Within every single line of business, Gross revenue serves as an indicator to measure the scale of commercial operations in each line of business to calculate the possible exposure to operational risk.
It is calculated simply by taking the three-year average of the sum of the regulatory capital charges for every single operating line in each year.
Advanced measurement approach (AMA)
Out of the 3 approaches to measuring operational risk, this is by far one of the most sophisticated methods. With an AMA model, banks can create their own empirical equation that quantifies how much capital they need for operations based on external data and scenarios in which those happen against a business environment analysis or internal control factors involved with it all.
One major component would be utilizing four quantitative elements: Loss Data (Internal), External Data Scenarios, And Environments Analysis Or Internal Control Factors Involved With The Process.
There are three different types of methodologies among the AMA models: internal measurement approach (IMA), loss distribution approach, and scorecard.
At CERO, we use the advanced measurement approach to estimate operational risk capital based on the loss distribution approach (LDA). This approach allows us to predict expected losses for the organization over a period of time, establish continuous improvement systems, create scenarios in order to simulate catastrophic events, and define loss indicators and thresholds,
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