LEGAL RISK :

With the changing economic scenario, banks are not only exposed to risks associated with the domestic markets, but also to international markets as well. More and more banking activities across borders, banks have to comply with more than one regulatory authority and also a number of legal frame work of international importance. The cross border or country specific legal requirements needs to be properly interpreted and understood and applied in the case of international trade and finance. The money laundering has become an important international issue; banks have to be careful in its operations. Banks should appoint international legal firms to handle their legal compliance to avoid legal risks.

The Basel Committee defines this risk as “The risk of loss arising out of inadequate or failed internal processes, people and systems, or from external events”. Banks have to make capital allocation for operational risks as well.

The revised BASEL II framework offers the following three approaches for estimating capital charges for operational risk:

(1) The Basic Indicator Approach (BIA): This approach sets a charge for operational risk as a fixed percentage (“alpha factor”) of a single indicator, such as the banks’ gross annual revenue.

(2) The Standardized Approach (SA): This approach requires that the bank separate its operations into eight standard business lines, such as trade finance, corporate banking and others. The capital charge for each business line is calculated by multiplying gross income of that business line by a factor (“beta”) assigned to that business line.

(3) Advanced Measurement Approach (AMA): Under this approach, the regulatory capital requirement will equal the risk measure generated by the banks’ internal operational risk measurement system.

As per the guidelines of the Reserve Bank of India, banks are required to integrate to the Basel II framework, with the Standardized Approach for Credit Risk and Basic Indicator Approach for Operational Risk. Banks are also required to upgrade their technology base to support implementation of Risk Assessment and Risk Management structure to meet the requirements of the Advanced Approaches under Basel II.