Capital Adequacy Framework

(Operational Risk)

Applicable to:
1. Licensed banks
2. Licensed investment banks
3. Licensed Islamic banks
4. Financial holding companies

Issued on: 15 December 2023 BNM/RH/PD 029-63

 Capital Adequacy Framework (Operational Risk)

TABLE OF CONTENTS

PART A OVERVIEW ................................................................................................ 1

1 Introduction ............................................................................................... 1
2 Effective date ............................................................................................ 2
3 Interpretation ............................................................................................. 2
4 Policy documents superseded .................................................................. 2

PART B POLICY REQUIREMENTS ........................................................................ 3

5 Total operational risk-weighted assets ...................................................... 3
6 Business Indicator Component ................................................................. 3
7 Internal Loss Multiplier (ILM) ..................................................................... 5

APPENDIX 1 DEFINITION OF COMPONENTS OF THE BUSINESS INDICATOR ....... 6

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PART A OVERVIEW

1 Introduction

1.1 This policy document sets out the standards and guidance for the calculation of
a financial institution’s operational risk-weighted assets under the Capital
Adequacy Framework and Capital Adequacy Framework for Islamic Banks.
These requirements are broadly in line with the Basel III standards set by the
Basel Committee on Banking Supervision (BCBS)1 and the capital standards
issued by the Islamic Financial Services Board (IFSB)2, and have been modified
accordingly where applicable.

1.2 The provisions on (i) the applicability of this policy document, (ii) legal provisions
pursuant to which this policy document is issued, (iii) terms and expressions
used in this policy document, (iv) the related legal instruments and policy
documents, and (v) level of application of this policy document shall be as
follows:

Policy Document Paragraph

Capital Adequacy Framework • Paragraph 2 on ‘Applicability’
(Capital Components) issued on 15 • Paragraph 3 on ‘Legal Provisions’
December 2023 and as may be • Paragraph 5 of ‘Interpretation’
amended by the Bank (hereinafter subject to the modifications in
“CAF CC PD”) paragraph 3 of this policy document
• Paragraph 6 on ‘Related legal
instruments and policy documents’,
subject to the modifications in
paragraph 1.3 of this policy
document
• Paragraph 8 on ‘Level of application’
Capital Adequacy Framework for • Paragraph 2 on ‘Applicability’
Islamic Banks (Capital • Paragraph 3 on ‘Legal Provisions’
Components) issued on 15 • Paragraph 5 of ‘Interpretation’
December 2023 and as may be subject to the modifications in
amended by the Bank (hereinafter paragraph 3 of this policy document
“CAFIB CC PD”) • Paragraph 6 on ‘Related legal
instruments and policy documents’,
subject to the modifications in
paragraph 1.3 of this policy
document
• Paragraph 8 on ‘Level of application’

1
Basel III: Finalising Post-Crisis Reforms, December 2017 (https://www.bis.org/bcbs/publ/d424.pdf)
2
IFSB 23: Revised Capital Adequacy Standard for Institutions Offering Islamic Financial Services
(https://ifsb.org/download.php?id=6310&lang=English&pg=/index.php)

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 Capital Adequacy Framework (Operational Risk) 2 of 10

1.3 This policy document must be read together with the policy documents as set
out in paragraph 1.2, and other relevant legal instruments, policy documents and
guidelines that have been issued by the Bank, including any amendments or
reissuance thereafter, including Operational Risk Reporting (ORR) issued on 1
November 2023.

2 Effective date

2.1 This policy document will come into effect on 1 January 2025.

3 Interpretation

3.1 The terms and expressions used in this policy document shall have the same
meanings assigned to them in the Financial Services Act 2013 (FSA), Islamic
Financial Services Act 2013 (IFSA), CAF CC PD and CAFIB CC PD, as the case
may be, unless otherwise defined in this policy document–

“financial institution” refers to both a financial institution as defined in CAF CC

PD and an Islamic financial institution as defined in CAFIB CC PD.

4 Policy documents superseded

4.1 This policy document supersedes Part C of the Capital Adequacy Framework
(Basel II – Risk-Weighted Assets) and Capital Adequacy Framework for Islamic
Banks (Risk-Weighted Assets) issued on 3 May 2019.

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 Capital Adequacy Framework (Operational Risk) 3 of 10

PART B POLICY REQUIREMENTS

5 Total operational risk-weighted assets

S 5.1 A financial institution shall calculate its total operational risk-weighted assets
(RWAOR) as follows:

RWA 𝑶𝑹 = 𝑲𝑶𝑹𝑪 × 12.5

where –
𝑲𝑶𝑹𝑪 is the operational risk capital requirements as set out in paragraph 5.2.

S 5.2 A financial institution shall calculate its operational risk capital requirements
(KORC) as follows:

𝑲𝑶𝑹𝑪 = BIC × ILM

where –
(a) BIC is the Business Indicator Component, as set out in paragraph 6.7;
and
(b) ILM is the Internal Loss Multiplier, as set out in paragraph 7.

6 Business Indicator Component

S 6.1 The BIC in paragraph 5.2 shall be a function of two elements:

(a) the Business Indicator (BI), which is set out in paragraph 6.2; and
(b) α which is the marginal coefficient to be applied based on the value of
the BI, as set out in paragraph 6.7.

S 6.2 A financial institution shall calculate the BI as follows:

BI = IPC + SC + FC

where –
(a) IPC is the Interest/Profit Component;
(b) SC is the Services Component; and
(c) FC is the Financial Component.

These components shall be calculated in accordance with paragraph 6.3.

S 6.3 A financial institution shall calculate the IPC, SC and FC components as follows:

(a) IPC= 𝑀𝑖𝑛 [ ̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅

𝐴𝑏𝑠(𝑖̇𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑖̇𝑛𝑐𝑜𝑚𝑒 + 𝑝𝑟𝑜𝑓𝑖̇𝑡 𝑖̇𝑛𝑐𝑜𝑚𝑒 − 𝑖̇𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 −
̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅
𝑝𝑟𝑜𝑓𝑖̇𝑡 𝑝𝑎𝑦𝑎𝑏𝑙𝑒), 2.25% × ( ̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅
𝑖̇𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑎𝑟𝑛𝑖̇𝑛𝑔 𝑎𝑠𝑠𝑒𝑡𝑠 + 𝑝𝑟𝑜𝑓𝑖̇𝑡
̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅ ̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅
𝑒𝑎𝑟𝑛𝑖̇𝑛𝑔 𝑎𝑠𝑠𝑒𝑡𝑠)] + 𝑑𝑖̇𝑣 𝑖̇𝑑𝑒𝑛𝑑 𝑖̇𝑛𝑐𝑜𝑚𝑒

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(b) SC = 𝑀𝑎𝑥[ ̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅

𝑜𝑡ℎ𝑒𝑟 𝑜𝑝𝑒𝑟𝑎𝑡𝑖̇𝑛𝑔 𝑖̇𝑛𝑐𝑜𝑚𝑒, ̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅
𝑜𝑡ℎ𝑒𝑟 𝑜𝑝𝑒𝑟𝑎𝑡𝑖̇𝑛𝑔 𝑒𝑥𝑝𝑒𝑛𝑠𝑒] +
̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅
𝑀𝑎𝑥[ 𝑓𝑒𝑒 𝑖̇𝑛𝑐𝑜𝑚𝑒, ̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅
𝑓𝑒𝑒 𝑒𝑥𝑝𝑒𝑛𝑠𝑒]

(c) FC = ̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅
𝐴𝑏𝑠(𝑁𝑒𝑡 𝑃&𝐿 𝑡𝑟𝑎𝑑𝑖̇𝑛𝑔 𝑏𝑜𝑜𝑘) + ̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅
𝐴𝑏𝑠(𝑁𝑒𝑡 𝑃&𝐿 𝑏𝑎𝑛𝑘𝑖̇𝑛𝑔 𝑏𝑜𝑜𝑘)

where –
(i) Abs () is the absolute value of the item within the brackets;
(ii) The income statement items refer to the quarterly value (as recorded in
the financial institution’s quarterly interim financial reports), and the
balance sheet items3 refer to the carrying amount at the end of quarter,
over the preceding twelve financial quarters4; and
(iii) A bar above the term indicates that the term is to be calculated as an
annualised three-year average5.

S 6.4 In calculating the components in paragraph 6.3, a financial institution shall

comply with the additional requirements under Appendix 16.

S 6.5 Where a financial institution has acquired a business of or merged with another
entity, the financial institution shall include the BI of the acquired business or
merged entity (as at prior to the effective date of the acquisition or merger) over
the period that is relevant to the calculation of the BI under paragraph 6.2.

S 6.6 Unless otherwise approved by the Bank, a financial institution which has
transferred a business7 or divested its shareholding in an entity to any other
person shall continue to include the BI of the transferred business or business
of the entity in which the financial institution had divested its shareholding over
the relevant period of its calculation of the BI under paragraph 6.2.

S 6.7 A financial institution shall compute the BIC referred to in paragraph 6.1 as
follows:

𝑩𝑰𝑪 = ∑(𝑩𝑰 × 𝜶𝒊 )
𝒊

where –
(i) ∑ is the sum of the items within the brackets for all buckets, 𝑖; and

3
Interest-earning assets and profit-earning assets.
4
Income statement and balance sheet items are categorised into 12 quarters (equivalent to 3 years)
consistent with the approach that had been adopted under Capital Adequacy Framework (Basel II –
Risk-Weighted Assets) and Capital Adequacy Framework for Islamic Banks (Risk-Weighted Assets),
or as may be amended or modified by the Bank.
5
A newly established financial institution which has been in operation for less than three years should
calculate the IPC, SC and FC over the entire period since it commenced operations, with the
components annualised accordingly.
6
Appendix 1 sets out the descriptions and examples of BI components, and the items to be excluded
from the BI.
7
For avoidance of doubt, this is referring to the transfer of business of a financial institution that falls
under section 100 of the FSA or section 112 of the IFSA, as the case may be.

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(ii) BI x α is computed for each bucket, 𝑖 , by multiplying the BI by the

corresponding marginal coefficients that are assigned to each BI range in
accordance with the table below:

Bucket, i BI range (RM billion) BI marginal coefficients, α

1 ≤1 12%
2 1 < BI ≤ 30 15%
3 > 30 18%

G 6.8 The BI marginal coefficients increase with the size of the BI. For financial
institutions in the first bucket (i.e. with a BI of less than or equal to RM1 billion),
the BIC is equal to BI x 12%. The marginal increase in the BIC resulting from a
one unit increase in the BI is 12% for Bucket 1, 15% for Bucket 2 and 18% for
Bucket 3. For example, given a BI = RM35 billion:

BIC = (1 x 12%) + [(30-1) x 15%] + [(35-30) x 18%] = RM5.37 billion

7 Internal Loss Multiplier (ILM)

S 7.1 Unless otherwise specified by the Bank, a financial institution shall set the ILM8
as 1.

S 7.2 Where the Bank specifies that a financial institution shall observe an ILM of
greater than 1 after having regard to the operational risk profile of the financial
institution and the adequacy of the risk mitigation measures that have been put
in place, the financial institution shall comply with the specification.

8
The financial institution’s internal operational risk loss experience may affect the calculation of
operational risk capital requirements through the ILM. In the event the Bank allows the application
of internal operational risk loss data, such loss data must comply with the requirements of ORR.

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APPENDIX 1 DEFINITION OF COMPONENTS OF THE BUSINESS

INDICATOR

S 1. A financial institution shall calculate components of the BI based on the

descriptions provided in the tables below9.

G 2. Non-exhaustive lists of examples of relevant sub-items from the income

statement or balance sheet are also provided for guidance.

S 3. Unless otherwise stated, the measurement of the items under Tables 1, 2 and
3 below shall be in accordance with the relevant Malaysian Financial Reporting
Standards (MFRS).

Table 1: Interest/Profit component (IPC)

Items Description Examples

(a) Interest income Interest income from all • Interest income from loans and
financial assets and advances, assets at fair value
other interest income. through profit or loss, assets at
fair value through other
This includes interest comprehensive income, assets
income from financial at amortised cost, trading
and operating leases, assets, financial leases and
and profits from leased operational leases
assets. • Interest income from hedge
accounting derivatives
• Other interest income
• Profits from leased assets
(b) Profit income10 Profit income from all • Profit income from all financing,
financing, financial assets at fair value through
assets and other profit profit or loss, assets at fair value
income. through other comprehensive
income, assets at amortised
This includes profit cost, trading assets,
income from leases/ijarah contracts
leases/ijarah contracts • Profit income from hedge
and investment accounting derivatives
accounts. • Other profit income not included
in the above categories
• Profit share/wakalah fees
income from investment
accounts
• Profits from leased assets

9
This includes the clarifications set out in the Capital Adequacy Framework (Operational Risk)
reporting template.
10
For Islamic banking operations. Any Shariah non-compliant sources of income shall be included
under ‘Other operating income’ (See Item (c) under Table 2 below).

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(c) Interest Interest expenses from • Interest expenses from

expenses all financial liabilities and deposits, debt securities issued,
other interest expenses. financial leases, and operating
leases
This includes interest • Interest expenses from hedge
expense from financial accounting derivatives
and operating leases, • Other interest expenses
depreciation and • Losses from leased assets
impairment of, as well as • Depreciation and impairment of
losses from, operating operating leased assets
leased assets.
(d) Profit Profit payments on all Expenses or returns payable on
payable11 financial liabilities and funds received from investment
other return payments. account holders, current account
deposits, sukuk issued,
This includes ijarah/leases contracts
depreciation and
impairment of, as well as
losses from, leased
assets.
(e) Interest- This includes all Total gross outstanding loans,
earning assets outstanding credit advances, interest-bearing
obligations in the securities (including government
balance sheet, including bonds), leased assets
credit obligations on non-
accrued status (e.g. non-
performing loans).
(f) Profit-earning This includes all Total gross outstanding financing,
assets11 outstanding credit sukuk, other profit-bearing financial
obligations in the assets (including sovereign sukuk),
balance sheet, including leased assets
credit obligations on non-
accrued status (e.g. non-
performing financing).
(g) Dividend Dividend income from investments in stocks and funds not
income consolidated in the financial institution's financial statements,
including dividend income from non-consolidated subsidiaries,
associates and joint ventures.

11
For Islamic banking operations.

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Table 2: Services component (SC)

Items Description Examples

(a) Fee and Income received from Fee and commission income from:
commission providing advice and • Securities (issuance,
income services. origination, reception,
transmission, execution of
This includes fees orders on behalf of customers)
received by the financial • Clearing and settlement
institution for the supply • Asset management
of financial services. • Custody
• Fiduciary transactions
• Payment services
• Structured finance
• Securitisations
• Loan/financing commitments
and guarantees
• Foreign transactions
(b) Fee and Expenses paid for Fee and commission expenses
commission receiving advice and from:
expenses services. • Securities (issuance,
origination, reception,
This includes transmission)
outsourcing fees paid by • Clearing and settlement
the financial institution • Asset management
for the supply of financial • Custody
services, but not • Fiduciary transactions
outsourcing fees paid for • Payment services
the supply of non- • Structured finance
financial services (e.g.
• Securitisations
logistical, IT, human
• Loan/financing commitments
resources).
and guarantees
• Foreign transactions
(c) Other Income from ordinary • Rental income from investment
operating banking operations not properties
income included in other BI • Gains from non-current assets
items. and disposal groups classified
as held for sale that do not
This excludes income qualify as discontinued
from operating leases. operations (MFRS 5.37)
• For Islamic banking operations,
income from non-Shariah
compliant sources, if any
(d) Other Expenses and losses • Losses from non-current assets
operating from ordinary banking and disposal groups classified
expenses operations not included as held for sale that do not
in other BI items, but of a qualify as discontinued
similar nature and operations (MFRS 5.37)

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stemming from • Losses incurred as a

operational loss events. consequence of operational loss
events (e.g. fines, penalties,
This excludes expenses settlements, replacement cost
from operating leases. of damaged assets), which have
not been previously
provisioned/reserved for
• Expenses related to
establishing provisions/
reserves for operational loss
events

Table 3: Financial component (FC)

Items Examples
(a) Net profit/loss • Net profit/loss on trading assets and trading liabilities
on the trading (including derivatives, debt securities/sukuk, equity
book securities, loans and advances, short positions, other
assets and liabilities)
• Net profit/loss from hedge accounting
• Net profit/loss from exchange differences
(b) Net profit/loss • Net profit/loss on financial assets and liabilities measured
on the banking at fair value through profit and loss
book • Realised gains/losses on financial assets and liabilities not
measured at fair value through profit and loss (including
loans and advances, assets at fair value through other
comprehensive income, assets at amortised cost, financial
liabilities measured at amortised cost)
• Net profit/loss from hedge accounting
• Net profit/loss from exchange differences

Excluded items

A financial institution shall exclude the following items from the BI calculation:
(a) income and expenses from insurance/takaful or reinsurance/retakaful
businesses;
(b) premiums/contributions paid and reimbursements/payments received from
insurance/takaful or reinsurance/retakaful policies/certificates purchased;
(c) recovery of administrative expenses including recovery of payments on behalf
of customers (e.g. taxes debited to customers);
(d) expenses of premises and fixed assets (except when these expenses result from
operational loss events);
(e) depreciation/amortisation of tangible and intangible assets (except depreciation
related to operating lease assets, which should be included in financial and
operating lease expenses);
(f) provisions/reversal of provisions (e.g. on pensions, commitments and
guarantees given) except for provisions related to operational loss events;
(g) expenses due to share capital repayable on demand;

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(h) impairment/reversal of impairment (e.g. on financial assets, non-financial assets,

investments in subsidiaries, joint ventures and associates);
(i) changes in goodwill recognised in profit or loss; and
(j) corporate income tax (tax based on profits including current and deferred tax).

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