Explain the risk which arises out of the external factors like non-compliance of regulatory and legal framework in banks. Describe the different approaches as per BASEL II framework for estimating capital charge for this

Operational Risk: The risks which arise out of the failure in internal systems and procedures, internal control system and/or human and system errors, and other internal/external factors like non-compliance of regulatory and legal frame work, frauds, misappropriation etc. One or more of these mentioned risks are collectively called as the Operational Risk. Thus Operational Risk covers the non-compliance of regulatory and legal frame work in banks. Operational risks can arise due to: Non-compliance with laid-down procedures and authorizations for dealing, settlement and custody. Fraudulent practices involving deals and settlements. Legal risks due to inadequate definitions and coverage of covenants and responsibilities of the bank and counterparty in contracts and agreements. Information Technology, which drives the markets, should be given importance in managing the risks, especially the operational risks. The quality of software, hardware and the up gradation of IT support system are very crucial for ensuring quick and correct transfer of financial transactions and funds across the international markets. Human Resource Management needs to be given proper attention to reduce the impact of operational risks through human errors and systems failure. Good and effective training would help to have better results and lesser operational risks. Non compliance of legal and/or regulatory frame work, due to inadequate definitions and coverage of covenants and responsibilities of the bank and counterparty in contracts. Frauds, insufficient internal control systems. Money laundering: International bank's main concern is to manage the money laundering activities. In view of the fast changing and increasing usage of technology, funds can be transferred from one end to the other part of the world quickly. The BASEL II framework offers the following three approaches for estimating capital charge for operational risk: 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. The Standardized Approach (SA): This approach requires that the banks 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 factory ('beta') assigned to that business line. 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.