Basic Indicator

Overview

Under a basic indicator approach, banks hold capital equal to the average of the previous three years of positive annual gross income, times a fixed proportionality factor. The basic indicator approach assumes that the total operational risk a bank faces is proportional to its income. That is, large banks face greater risk than smaller banks, where the risk is assumed to scale approximately with income.

The three year window is set in order to smooth earnings in order to get a more accurate measure. For years in which the earnings are negative, the earnings are excluded from the average. For example, if only two of the last three years had positive earnings, only those two years are included in the calculation.

Proportionality factors are assigned to business units within a bank, rather than the bank as a whole. This is because some units are seen to be riskier than others. A bank calculating its operational risk capital should calculate the capital on a per business unit basis, and then add them together to get the total bank capital.