medium · FRM Part 2 Operational Risk
A bank is calculating its operational risk capital under the Standardized Measurement Approach (SMA). The Business Indicator (BI) is €42 billion and the 10-year average annual loss is €600 million.
If the Internal Loss Multiplier (ILM) is calculated to be 1.097, what does this imply about the bank's loss history relative to its size?
- The ILM of 1.097 indicates the bank must now discontinue the SMA and revert to its own internal Advanced Measurement Approach model.
- The bank's loss history is 'dirty' and adds approximately 10% to the capital charge compared to a bank of the same size with average losses.
- The bank's loss history is deemed 'clean' because the €600 million average annual loss is well below the 2% threshold relative to the total BI.
- The ILM will be disregarded entirely because Basel III mandates a fixed ILM of exactly 1.0 for every bank placed into Bucket 3, regardless of loss history.
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