INTM267741 | Foreign banks trading in the UK through permanent establishments: The approach in determining an adjustment to funding costs - STEP 2: Risk weighting the assets - the Basel II regulatory regime: Pillar 1 - operational risk

The requirement to hold capital to support operational risk losses is entirely new and is covered at “Prudential sourcebook for Banks, Building Societies and Investment Firms” (BIPRU) 6. The definition of operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events including legal risk. Banks are allowed to choose one of three different approaches to the process of risk weighting:

• The Basic Indicator Approach (BIA)

• The Standardised Approach (TSA)

• The Advanced Management Approach (AMA)

Pillar 2 is where the true extent of operational risk is assessed.

The Bank of International Settlements (BIS) considers that operational risk with the potential for substantial losses may arise from:

• Internal fraud

• External fraud

• Employee practices and workplace safety

• Clients, products and business practices

• Damage to physical assets

• Business disruption and systems failure

• Execution, delivery and process management