please explain how Basic indicator approach helps mitigate operational risk Approach #1: Basic Indicator ApproachThe basic indicator approach is one of the earliest approaches which was recommended by the Bank of InternationalSettlements in its Basel norms. Compared to the current method, it seems like a crude back-of-the-envelope calculation today.However, it is still widely useful for banks that do not have a significant international presence.The purpose of the basic indicator approach is to help the banks calculate the amount of capital that they need to set aside tomeet operational risk requirements. This is done in three steps.Step 1: Calculate a fixed percentage known as alpha. In most parts of the world, this number is 15%.Step 2: Calculate the positive gross income over the past three-year period. It is important to note the emphasis on the wordpositive. If the income is less than zero, then it should be excluded both from the numerator and denominator. Also,extraordinary one-time incomes, as well as expenses, should be excluded from the calculation. The positive gross income forthe past three years needs to be averaged in order to arrive at a number.Step 3: Multiple the alpha with the average gross income over the past three years to derive the amount of capital that needsto be set aside for risk management purposes.

Every business has to take risk in its operational activities. This risk has to be managed…

Answered: please explain how Basic indicator…

Understanding Business

12th Edition

ISBN:9781259929434

Author:William Nickels

Publisher:William Nickels

Chapter1: Taking Risks And Making Profits Within The Dynamic Business Environment

Section: Chapter Questions

Problem 1CE

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On-Balance Sheet Items (Assets) (in millions) Cash $ 10,000 Government securities 30,000 Interbank deposits 5,000 Home loans to personal finance customers 20,000 Loans to corporate customers 75,000 Total Balance Sheet Assets $140,000 Off-Balance Sheet Items Standby letters of credit backing corporate borrowings $ 10,000 Long term unused loan commitments made to private corporations 20,000 Total Off-Balance Sheet Items $30,000 Bank Capital Common stock (par value) $ 1,000 Surplus 1,500 Retained earnings 1,500 Subordinated debentures 2,000 Minority interest in subsidiaries 1,000 Allowance for loan and lease losses (reserves) 1,000 Non cumulative perpetual preferred stock 1,000 Intermediate term preferred stock 4,000 Equity commitment notes 2,000 Basel…
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