RBI's New Operational Risk Capital Rules: Basel III SA

RBI/DOR/2023-24/103 DOR.ORG.REC.22/21.06.050/2023-24 June 26, 2023 Reserve Bank of India – Master Direction on Minimum Capital Requirements for Operational Risk In exercise of the powers conferred by Section 35A of the Banking Regulation Act, 1949, the Reserve Bank of India being satisfied that it is necessary and expedient in the public interest to do so, hereby issues the Directions hereinafter specified. These Directions require a specified Commercial Bank (covered under ‘Applicability’) to hold sufficient regulatory capital against its exposures arising from operational risk. Part A 1. Short Title and Commencement These Directions shall be called the Reserve Bank of India (Minimum Capital Requirements for Operational Risk) Directions, 2023. 2. Effective Date 2.1 The effective date of implementation of these Directions shall be communicated separately. 2.2 All existing approaches viz. Basic Indicator Approach (BIA), The Standardised Approach (TSA)/ Alternative Standardised Approach (ASA) and Advanced Measurement Approach (AMA) for measuring minimum operational risk capital (ORC) requirements shall be replaced by the new Standardised Approach (hereafter referred to as the ‘ Basel III Standardised Approach ’) with coming into effect of these Directions. 2.3 Until then, the minimum operational risk regulatory capital requirements shall be computed in accordance with the instructions contained in paragraph 9 of ‘Master Circular – Basel III Capital Regulations’ issued vide circular DOR.CAP.REC.15/21.06.201/2023-24 dated May 12, 2023 , as amended from time to time. 3. Applicability 3.1 The provisions of these Directions shall apply to all Commercial Banks (excluding Local Area Banks, Payments Banks, Regional Rural Banks, and Small Finance Banks). 3.2 The scope of application shall be in accordance with paragraph 3 of ‘Master Circular – Basel III Capital Regulations’ issued vide circular DOR.CAP.REC.15/21.06.201/2023-24 dated May 12, 2023 , as amended from time to time. 3.3 The provisions contained in Part A of these Directions are mandatory. Banks are encouraged to comply with the guidelines listed in Part B . Part C and Part D contain Frequently Asked Questions (FAQs) and Illustrations, respectively (for general guidance of banks). 4. Definitions 4.1 In these Directions, unless the context otherwise requires, 4.1.1 “Commercial Banks” means all banking companies 1 , corresponding new banks, and State Bank of India as defined under subsections (c), (da), and (nc) respectively of Section 5 of the Banking Regulation Act, 1949 (hereinafter referred to as ‘Bank(s)’) 4.1.2 “Gross loss” means a loss before recoveries of any type. 4.1.3 “Net loss” means the loss after taking into account the impact of recoveries. 4.1.4 “Operational risk” means the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk 2 , but excludes strategic and reputational risk. 4.1.5 “Recovery” is an independent occurrence, related to the original loss event, separate in time, in which funds or inflows of economic benefits are received from a third party. 3 4.2 All other expressions unless defined herein shall have the same meaning as have been assigned to them under the Banking Regulation Act, 1949 or the Reserve Bank of India Act, 1934, or Glossary of Terms published by Reserve Bank or as used in commercial parlance, as the case may be. 5. Components of Basel III Standardised Approach (Basel III SA) 5.1 Basel III SA calculation methodology is based on the following components: 5.1.1 the Business Indicator (BI) , which is a financial-statement-based proxy for operational risk; 5.1.2 the Business Indicator Component (BIC) , which is calculated by multiplying the BI by a set of marginal coefficients (αi); and 5.1.3 the Internal Loss Multiplier (ILM) , which is a scaling factor that is based on a bank’s average historical losses and the BIC. 5.2 Business Indicator (BI) The BI shall be the summation of the following three constituents, BI = ILDC+SC+FC Where, ILDC is the Interest, Lease and Dividend Component; SC is the Services Component; and FC is the Financial Component. 5.3 Computation of ILDC, SC and FC The ILDC, SC and FC shall be computed as per the formula below, where a bar above a term indicates that it is calculated as the average over three years 4 : t, t-1 and t-2, and: Where, Max=Maximum, Min=Minimum, and Abs= Absolute value of sub-components irrespective of their signs (+ or -) The description for each of these constituents of the BI is provided in Annex 1 . 5.4 Business Indicator Component (BIC) The BIC shall be calculated by multiplying the BI with the marginal coefficients (αi), (which increase with the size of the BI) as shown in Table 1 below. Table 1

Reproduced for reference with acknowledgment — Source: Reserve Bank of India · RBI/DOR/2023-24/103 · issued 26 Jun 2023. The plain-English explanation above is BankPulse’s own independent summary.

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