Basic indicator approach

The basic approach or basic indicator approach is a set of operational risk measurement techniques proposed under Basel II capital adequacy rules for banking institutions.

Basel II requires all banking institutions to set aside capital for operational risk. Basic indicator approach is much simpler compared to the alternative approaches (i.e. standardized approach (operational risk) and advanced measurement approach) and thus has been recommended for banks without significant international operations.

Based on the original Basel Accord, banks using the basic indicator approach must hold capital for operational risk equal to the average over the previous three years of a fixed percentage of positive annual gross income. Figures for any year in which annual gross income is negative or zero should be excluded from both the numerator and denominator when calculating the average.

The fixed percentage ‘alpha’ is typically 15 percent of annual gross income.

See also

• Standardized approach (operational risk)
• Advanced measurement approach
• Capital Requirements Directive
• Operational risk
• Reputational risk
• Basel II

References

• http://www.bis.org/publ/bcbsca.htm Basel II: Revised international capital framework (BCBS)
• http://www.bis.org/publ/bcbs107.htm Basel II: International Convergence of Capital Measurement and Capital Standards: a Revised Framework (BCBS)
• http://www.bis.org/publ/bcbs118.htm Basel II: International Convergence of Capital Measurement and Capital Standards: a Revised Framework (BCBS) (November 2005 Revision)
• http://www.bis.org/publ/bcbs128.pdf Basel II: International Convergence of Capital Measurement and Capital Standards: a Revised Framework, Comprehensive Version (BCBS) (June 2006 Revision)