According to Article 4 (52) of the Capital Requirements Regulation (CRR), “operational risk” means the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events, and includes legal risk.
The CRR envisages three alternative methods for calculating the own funds requirements for operational risk:
- Basic Indicator Approach (BIA) – Article 315 f. CRR
- Standardised Approach (STA)/Alternative Standardised Approach (ASA) – Article 317 ff. CRR
- Advanced Measurement Approaches (AMA) – Article 321 ff. CRR
The calculation basis for the Basic Indicator Approach and the Standardised Approach is the three-year average of the “relevant indicator”, which is calculated from certain items in the profit and loss account (net interest and net commissions received, the trading result, and other operating income). When using the Basic Indicator Approach, multiplying the “relevant indicator” by a fixed factor of 15% produces the own funds requirements.
An institution must notify supervisors if it intends to use the Standardised Approach. In order to calculate capital requirements using the Standardised Approach, the “relevant indicator” must be divided into the eight business lines defined in Article 317 CRR and multiplied by a factor of 12%, 15%, or 18%. In accordance with Article 319 CRR, and subject to permission from banking supervisors, institutions that predominantly conduct retail or commercial banking may opt to use the Alternative Standardised Approach. In the Alternative Standardised Approach, the capital charge in the relevant business lines is calculated by multiplying the nominal amount of loans and advances by a factor of 0.035, as stipulated by banking supervisors. In addition, qualitative standards must be fulfilled when using the Standardised Approach.
If an institution has been given permission by supervisors to use an Advanced Measurement Approach pursuant to Article 321 ff. CRR, it may, in compliance with qualitative and quantitative supervisory standards, use an internal model to calculate its own funds requirements. The model must be examined and approved by supervisors in advance. If material changes or extensions are made to an institution’s internal model that has already been approved by supervisors, the model must be reviewed by supervisors once again.
The current approaches were revised by the Basel Committee in 2017 during the course of finalising the Basel III framework. On this basis, only one approach is to be applied in future: the new Standardised Approach to Operational Risk (SA OR), which is intended to be implemented in the European Union as part of CRR 3. In methodological terms, the new SA OR is modelled on the Basic Indicator Approach and the previous Standardised Approach. Through the introduction of a loss component, the SA OR additionally allows an institution’s historical operational risk-related losses to be taken into account when calculating own funds requirements. The Basel Committee has decided that application of the loss component will be optional. Subsequently, there will no longer be the option of using model-based approaches with regard to Pillar 1 requirements.