Operational Risk Management

Chapter 10

Regulatory Requirements

Learning objectives

After studying this chapter, you should be able to:

1 Understand and explain the evolution of the Basel II capital accords and the three Pillars that frame their approach to operational risk management

2 Discuss the HKMA’s approach to setting the capital charge for banks and other authorised institutions

3 Explain the basic indicator approach, standardised approach, and advanced measurement approach to setting the capital charge for a financial institution

Introduction

We have already discussed, to some degree, the regulatory framework that guides operational risk management practices. In this chapter we discuss how regulators use this framework to calculate the capital charge that banks should set aside to protect themselves, and the industry, from loss events associated with operational risk factors.

The regulatory framework for operational risk is not only relatively recent but it is also evolving. In fact, while the BCBS of the BIS introduced the Basel II accords in 2004, which include extended discussion on how regulators can approach operational risk management at the banks in their jurisdictions, the standards have continued to evolve. In fact, a Basel III package is likely to be implemented in stages from January 2013. The HKMA adopted Basel II standards in 2007.

The Basel II accords are based on a three-pillar approach that we discussed earlier in this book. Here we explore each pillar in somewhat more depth, touching ...