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560. Minimum standards for the use of each approach are shown below.

1.

T

B

I

A

561. The basic indicator approach is intended to be applicable to any bank regardless of its complexity or sophistication. As such, no criteria for use apply. Nevertheless, banks using this approach will be urged to comply with the Committee’s guidance on Operational Risk Sound Practices, which is currently being developed and which will be released in the future. This document will also serve as guidance to supervisors under Pillar 2.

2.

T

S

A

562. As well as meeting the Basel Committee’s Operational Risk Sound Practices, banks will have to meet the following standards to be eligible for the standardised approach:

(i)

Effective risk management and control

563. The qualitative standards that banks must meet include the following: existence of an independent risk control and audit functions, effective use of risk reporting systems, active involvement of board of directors and senior management and appropriate documentation of risk management systems.

• Banks must establish an independent operational risk management and control process, which covers the design, implementation and review of its operational risk measurement methodology. Responsibilities include establishing the framework for the measurement of operational risk and control over the construction of the operational risk methodology and key inputs.

• Banks’ internal audit groups must conduct regular reviews of the operational risk management process and measurement methodology.

(ii)

Measurement and validation

• Banks must have both appropriate risk reporting systems to generate data used in the calculation of a capital charge and the ability to construct management reporting based on the results.

• Banks must begin to systematically track relevant operational risk data by business line.

• Banks will have to develop specific, documented criteria for mapping current business lines and activities into the standardised framework. The framework has to be reviewed and adjusted for new or changing business activities and risks as appropriate.

3.

I

M

A

564. In addition to the standards required for banks using the Standardised Approach, banks wishing to use the Internal Measurement Approach will have to meet the following standards:

(i)

Effective risk management and control

565. Accuracy of loss data, and confidence in the results of calculations using that data, (including PEs and LGEs), have to be established through “use tests”. Banks have to use the collected data and the resulting measures for risk reporting, management reporting, internal capital allocation purposes, risk analysis, etc. Banks that do not fully integrate an internal measurement methodology into their day-to-day activities and major business decisions will not qualify for this approach.

(ii)

Measurement and validation

• Banks must develop sound internal loss reporting practices, supported by loss database systems that are consistent with the scope of operational risks defined by supervisors and the banking industry.

• Banks must have an operational risk measurement methodology, knowledgeable and skilled staff, and an appropriate systems infrastructure capable of identifying and gathering comprehensive operational risk loss data necessary to create a loss database and calculate appropriate PEs and LGEs. Systems must be able to gather data from all appropriate sub-systems and geographic locations. Missing data from various systems, groups or locations must be explicitly identified and tracked.

• Banks must have in place a sound process to identify in a consistent manner over time the events used to construct a loss database and to be able to identify which historical loss experiences are appropriate for the institution and are representative of their current and future business activities. This entails developing and defining loss data criteria in terms of the type of loss data and the severity of the loss data that goes beyond the general supervisory definition and specifications.

• Banks wishing to use external data must establish procedures for the use of such data. They must specify procedures and methodologies for the scaling of external loss data or internal loss data from other sources. These conditions and practices must be regularly reviewed, documented, and subject to periodic independent review.

• Sources of external data must be reviewed regularly in order to ensure their accuracy and applicability. Banks must review and understand the assumptions used in the collection and assignment of loss events and resultant loss statistics.

• A bank’s operational risk loss database must extend for a number of years (to be set by the Committee), for significant business lines. Additionally, banks must develop specific criteria for assigning loss data to a particular business line and risk types. A process has to be developed to identify and incorporate plausible historically large or significant events into the database, which may range beyond the observation period. These processes have to be clearly documented and be specific enough for independent review and verification.

• Banks must regularly conduct validation of their loss rates, risk indicators and size estimations in order to ensure that inputs to the regulatory capital charge are reliable.

• Regulators will examine the data collection and validation process and comment on the control environment of the institution.

• Banks must adhere to rigorous processes in estimating parameters such as EI, PE, and LGE.

• Bank management should incorporate experience and judgement into an analysis of the loss data and the resulting PEs and LGEs. Banks must identify clearly the exceptional situations under which judgmental overrides may be used, to what extent they are to be used and who is authorised to make such decisions. The conditions under which these overrides may be made and detailed records of changes must be clearly documented and subject to independent review.

VI. Trading book issues