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Location: Central Bank of Bahrain Volume 1—Conventional Banks > Part A > Business Standards > CA Capital Adequacy > PART 3: Other Risks > CA-7 Operational Risk
  • CA-7 Operational Risk

    • CA-7.1 The Measurement Methodologies

      • CA-7.1.1

        The framework outlined below presents two methods for calculating operational riskG capital charges in a continuum of increasing sophistication and risk sensitivity:

        (a) The Basic Indicator Approach; and
        (b) The Standardised Approach.
        January 2015

      • CA-7.1.2

        Conventional bank licenseesG are encouraged to move towards standardised approach as they develop more sophisticated operational riskG measurement systems and practices.

        January 2015

      • CA-7.1.3

        A conventional bank licenseeG will not be allowed to choose to revert to basic indicator approach once it has been approved for standardised approach without CBB's approval. However, if CBB determines that a conventional bank licenseeG using standardised approach no longer meets the qualifying criteria for standardised approach, it may require the conventional bank licenseeG to revert to basic indicator approach for some or all of its operations, until it meets the conditions specified by the CBB for returning to standardised approach.

        January 2015

      • Basic Indicator Approach

        • CA-7.1.4

          Conventional bank licenseesG applying the Basic Indicator Approach must hold capital for operational riskG equal to the average over the previous three years of a fixed percentage (denoted alpha) of positive annual gross income. Figures for any year in which annual gross income is negative or zero must be excluded from both the numerator and denominator when calculating the average.37 The charge may be expressed as follows:
          KBIA = [∑(GI1.nα)]/n

          where:

          KBIA = the capital charge under the Basic Indicator Approach

          GI = annual gross income, where positive, over the previous three years (audited financial years)

          n = number of the previous three years for which gross income is positive

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


          37 If negative gross income distorts a bank's Pillar 1 capital charge, CBB will consider appropriate supervisory action.

          January 2015

        • CA-7.1.5

          Gross income is defined as net interest income plus net non-interest income.38 This measure should: (i) be gross of any provisions (e.g. for unpaid interest); (ii) be gross of operating expenses, including fees paid to outsourcing service providers39; (iii) exclude realised profits/losses from the sale of securities in the banking book;40 and (iv) exclude extraordinary or irregular items as well as income derived from insurance.


          38 As defined under International Financial Reporting Standards as applicable in the Kingdom of Bahrain.

          39 In contrast to fees paid for services that are outsourced, fees received by banks that provide outsourcing services shall be included in the definition of gross income.

          40 Realised profits/losses from securities classified as "held to maturity" and "available for sale", which typically constitute items of the banking book, are also excluded from the definition of gross income.

          January 2015

        • CA-7.1.6

          In case of a bank with negative gross income for the previous three years, a newly licensed bank with less than 3 years of operations, or a merger, acquisition or material restructuring, the CBB shall discuss with the concerned licensed bank an alternative method for calculating the operational riskG capital charge. For example, a newly licensed bank may be required to use the projected gross income in its 3-year business plan. Another approach that the CBB may consider is to require such licensed banks to observe a higher CAR.

          January 2015

        • CA-7.1.7

          Conventional bank licenseesG applying this approach are encouraged to comply with the principles set in Section OM-8.2 of Operational Risk Management Module.

          January 2015

      • The Standardised Approach

        • CA-7.1.8

          In the Standardised Approach, banks' activities are divided into eight business lines: corporate finance, trading & sales, retail banking, commercial banking, payment & settlement, agency services, asset management, and retail brokerage. The business lines are defined in detail in Appendix CA-9. The conventional bank licenseeG must meet the requirements detailed in Section OM-8.3 to qualify for the use of standardised approach.

          January 2015

        • CA-7.1.9

          Within each business line, gross income is a broad indicator that serves as a proxy for the scale of business operations and thus the likely scale of operational riskG exposure within each of these business lines. The capital charge for each business line is calculated by multiplying gross income by a factor (denoted beta) assigned to that business line. Beta serves as a proxy for the industry-wide relationship between the operational riskG loss experience for a given business line and the aggregate level of gross income for that business line. It should be noted that in the Standardised Approach, gross income is measured for each business line, not the whole institution, i.e. in corporate finance, the indicator is the gross income generated in the corporate finance business line. An example of calculation of gross income is provided in Appendix CA-10.

          January 2015

        • CA-7.1.10

          The total capital charge is calculated as the three-year average of the simple summation of the regulatory capital charges across each of the business lines in each year. In any given year, negative capital charges (resulting from negative gross income) in any business line can not off-set positive capital charges in other business lines. Where the aggregate capital charge across all business lines within a given year is negative, then the input to the numerator for that year will be zero.41 The total capital charge may be expressed as:

          KTSA = {∑ years 1-3 max[(GI1-8 X β1-8, 0]}/3

          where:

          KTSA = the capital charge under the Standardised Approach

          GI 1-8 = annual gross income in a given year, as defined above in the Basic Indicator Approach, for each of the eight business lines

          β1-8 = a fixed percentage, relating the level of required capital to the level of the gross income for each of the eight business lines.

          The values of the betas are detailed below.

          Business Lines Beta Factors
          Corporate Finance (β1) 18%
          Trading and Sales (β2) 18%
          Retail Banking (β3) 12%
          Commercial Banking (β4) 15%
          Payment and Settlement (β5) 18%
          Agency Services (β6) 15%
          Asset Management (β7) 12%
          Retail Brokerage (β8) 12%

          41 As under the Basic Indicator Approach, if negative gross income distorts a bank's Pillar 1 capital charge under the Standardised Approach, CBB will consider appropriate supervisory action.

          January 2015

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