and to calculate a capital reserve against future operational losses. In addition to the Basel II requirement for banks, this is now a requirement for European insurance firms who are in the process of implementing Solvency II, the equivalent of Basel II for the insurance sector. Methods for calculating operational risk capital Basel II and various supervisory bodies of the countries have prescribed various soundness standards for operational risk management for banks and similar financial institutions. To complement these standards, Basel II has given guidance to 3 broad methods of capital calculation for operational risk: Basic Indicator Approach – based on annual revenue of the Financial Institution Standardized Approach – based on annual revenue of each of the broad business lines of the Financial Institution Advanced Measurement Approaches – based on the internally developed risk measurement framework of the bank adhering to the standards prescribed (methods include IMA, LDA, Scenario-based, Scorecard etc.) The operational risk management framework should include identification, measurement, monitoring, reporting, control and mitigation frameworks for operational risk. There are a number of methodologies to choose from when modeling operational risk, each with its advantages and target applications. The ultimate choice of the methodology/methodologies to use in your institution depends on a number of factors, including: Time sensitivity for analysis; Resources desired and/or available for the task; Approaches used for other risk measures; Expected use of results (e.g., allocating capital to business units, prioritizing control improvement projects, satisfying regulators that your institution is measuring risk, providing an incentive for better management of operational risk, etc.); Senior management understanding and commitment; and Existing complementary processes, such as self-assessment Standardised Measurement Approach (Basel III) The Basel Committee on Banking Supervision (BCBS) has proposed the "Standardised Measurement Approach" (SMA) as a method of assessing operational risk as a replacement for all existing approaches, including AMA. The objective is to provide stable, comparable and risk-sensitive estimates for the operational risk exposure and is effective January 1, 2022. The SMA puts weight on the internal loss history (losses of the last 10 years must be considered). It is possible to consider net losses (after recoveries and insurance). The marginal coefficient (α) increases with the size of the BI as shown in the table below. The ILM is defined as: where the Loss Component (LC) is equal to 15 times average annual operational risk losses incurred over the previous 10 years. See also Crisis