Since banks might suffer losses as a result of operational risk, they're also required to hold regulatory capital to reduce the risk of bankruptcy.

Should an operational risk event occur the way banks calculate the amount of regulatory capital that they need to hold for operational risk has evolved over the years.

Under Basel two, there were three options ranging in complexity, similar to the methods for calculating credit and market risk.

However, the nature of operational risk is very different to credit and market risk.

Operational risk losses typically involve a very high number of low cost operational risk events, such as a minor processing error, which leads to delay in settlement of a transaction and a small interest compensation payments, and a very low number of high cost operational risk events, such as high profile insider trading or cyber attack events, which lead to losses, fines, or compensation payments.

Another way of expressing this is that there is significant positive skew to the distribution of loss severity.

This meant that traditional loss models such as value at risk v ar may not be appropriate since the type of loss, which might be large enough to bankrupt a bank, may be of such low probability that it wouldn't be covered by a 99% or even a 99.9% value at risk model.

This issue was further highlighted during the global financial crisis of 2008, where regulators observed that existing operational risk capital requirements under Basel two were not sufficient to cover the operational losses incurred by some firms.

In addition, the financial crisis also highlighted that the sources of these losses, including those related to fines for misconduct or poor controls, were difficult to predict using the internal models approach available under Basel two.

In response, Basel three introduced a new operational risk framework that replaced all existing operational risk approaches for calculating capital requirements.

Replaced with a single standardized approach referred to as the standardized measurement approach, or SMA, which considers the size of the bank as well as its historical operational loss history.

The Basel three rule makers Believed that the implementation of the standardized approach would better enhance the safety and soundness of banks.

It would also facilitate a better comparison of risk weighted assets between firms by removing the use of multiple concepts and methods available under Basel two and removing the use of firm's internal models for estimating operational risk.