The Standardized Approach

• Consistent with Part I (Scope of Application) of the Basel II Framework, the standardised  approach applies to internationally active banks on a consolidated basis. Supervisors retain the  discretion to apply the standardised approach framework to non-internationally active banks.

• The standardised approach methodology is based on the following components:
  • The Business Indicator (𝐵𝐼) which is a financial-statement-based proxy for operational  risk
  • The Business Indicator Component (𝐵𝐼𝐶), which is calculated by multiplying the 𝐵𝐼 by a  set of regulatory determined marginal coefficients (𝛼_i)
  • The Internal Loss Multiplier (𝐼𝐿𝑀), which is a scaling factor that is based on a bank’s  average historical losses and the 𝐵𝐼𝐶
• The Business Indicator (𝐵𝐼) comprises of three components:
  • The Interest, Leases and Dividend component (𝐼𝐿𝐷𝐶)
  • The Services Component (𝑆𝐶)
  • The Financial Component (𝐹𝐶)

𝐵𝐼  = 𝐼𝐿𝐷𝐶 + 𝑆𝐶  + 𝐹𝐶

Business Indicator Definitions
BI Component	P&L or Balance Sheet Items	Description	Typical Sub-items
Interest, Lease and Dividend	Interest Income	Interest income from all financial assets and other interest income (includes interest income from financial and operating leases and profits from leased assets)	Interest income from loans and advances, assets available for sale, assets held to maturity, trading assets, financial leases, and operational leases Interest income from hedge accounting derivatives Other interest income Profits from leased assets
	Interest Expenses	Interest expenses from all financial liabilities and other interest expenses (includes interest expense from financial and operating leases, losses, depreciation, and impairment of operating leased assets)	Interest expenses from deposits, debt securities issued, financial leases, and operating leases Interest expenses from hedge accounting derivatives Other interest expenses Losses from leased assets Depreciation and impairment of operating leased assets
	Interest earning assets (balance sheet item)	Total gross outstanding loans, advances, interest-bearing securities (including government bonds), and lease assets measured at the end of each financial year
	Dividend Income	Dividend income from investments in stocks and funds not consolidated in the bank’s financial statements, including dividend income from non-consolidated subsidiaries, associates, and joint ventures

Business Indicator Definitions
BI Component	P&L or Balance Sheet Items	Description	Typical Sub-items
Services	Fee and commission income	Income received from providing advice and services. Includes income received by the bank as an outsourcer of financial services	Fee and commission income from: Securities (issuance, origination, reception, transmission, execution of orders on behalf of customers) Clearing and settlement; Asset management; Custody Fiduciary transactions; Payment services; Structured finance; Servicing of securitisations; Loan commitments
	Fee and commission expenses	Expenses paid for receiving advice and services. Includes outsourcing fees paid by the bank for the supply of financial services, but not outsourcing fees paid for the supply of nonfinancial services (e.g., logistical, IT, human resources)	Fee and commission expenses from: Clearing and settlement; Custody; Servicing of Securitizations Loan commitments and guarantees received; and Foreign transactions
	Other operating income	Income from ordinary banking operations not included in other BI items but of similar nature (income from operating leases should be excluded)	Rental income from investment properties Gains from non-current assets and disposal groups classified as held for sale not qualifying as discontinued operations

Business Indicator Definitions
BI Component	P&L or Balance Sheet Items	Description	Typical Sub-items
Services	Other operating expenses	Expenses and losses from ordinary banking operations not included in other BI items but of similar nature and from operational loss events (expenses from operating leases should be excluded)	Losses from non-current assets and disposal groups classified as held for sale not qualifying as discontinued operations Losses incurred as a consequence of operational loss events (e.g., fines, penalties, settlements, replacement cost of damaged assets), which have not been provisioned/reserved for in previous years Expenses related to establishing provisions/reserves for operational loss events
Financial	Net profit (loss) on the trading book	Net profit/loss on trading assets and trading liabilities (derivatives, debt securities, equity securities, loans and advances, short positions, other assets and liabilities) Net profit/loss from hedge accounting Net profit/loss from exchange differences
	Net profit (loss) on the banking book	Net profit/loss on financial assets and liabilities measured at fair value through profit and loss Realised gains/losses on financial assets and liabilities not measured at fair value through profit and loss (loans and advances, assets available for sale, assets held to maturity, financial liabilities measured at amortized cost) Net profit/loss from hedge accounting Net profit/loss from exchange differences

The Standardized Approach-Business Indicator

• The Business Indicator (𝐵𝐼) comprises of three components:
  • The Interest, Leases and Dividend component (𝐼𝐿𝐷𝐶)
  • The Services Component (𝑆𝐶)
  • The Financial Component (𝐹𝐶)

𝐵𝐼  = 𝐼𝐿𝐷𝐶 + 𝑆𝐶  + 𝐹𝐶

• In the above formulas, a bar above a term indicates that it is calculated as the average over  three years: 𝑡, 𝑡 — 1 and 𝑡 — 2.

The Standardized Approach-Business Indicator Component

• To calculate the 𝐵𝐼𝐶, the 𝐵𝐼 is multiplied by the marginal coefficients (𝛼_i). The marginal  coefficients increase with the size of the 𝐵𝐼 as shown in this table.

Bucket	BI Range (in € billion)	BI Marginal Coefficients
1	≤ 1	12%
2	1 < BI ≤ 30	15%
3	> 30	18%

• For banks in the first bucket (i.e., with a 𝐵𝐼 less  than or equal to €1 bn) 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% in bucket 1,  15% in bucket 2 and 18% in bucket 3.

• For example, given a 𝐵𝐼 = €35bn, the 𝐵𝐼𝐶 = (1 𝑋 12%) + (30 — 1) 𝑋 15%  + (35 — 30) 𝑋 18% = €5.37bn.

The Standardized Approach-Internal Loss Multiplier

• A bank’s  internal operational risk loss experience affects the calculation of  operational risk  capital through the Internal Loss Multiplier (𝐼𝐿𝑀). The 𝐼𝐿𝑀 is defined as:

where the Loss Component (𝐿𝐶) is equal to 15 times average annual operational risk losses  incurred over the previous 10 years.

• The 𝐼𝐿𝑀 is equal to 1 when the loss and business indicator components are equal

• When the 𝐿𝐶 is greater than the 𝐵𝐼𝐶, the 𝐼𝐿𝑀 is greater than 1.

• Thus, a bank with losses that are high relative to its 𝐵𝐼𝐶 is required to hold higher capital due  to the incorporation of internal losses into the calculation methodology.

• Conversely, where the 𝐿𝐶 is lower than the 𝐵𝐼𝐶, the 𝐼𝐿𝑀 is less than 1. That is, a bank with  losses that are low relative to its 𝐵𝐼𝐶  is required to hold lower capital due to the incorporation  of internal losses into the calculation methodology.

• The calculation of average losses in the Loss Component must be based on 10 years of high-  quality annual loss data. As part of the transition to the standardized approach, banks that do  not have 10 years of high-quality loss data may use a minimum of 5 years of  data to calculate  the Loss Component.

• Banks that do not have 5 of high-quality loss data must calculate the capital requirement based  solely on the 𝐵𝐼 Component. Supervisors may however require a bank to calculate capital  requirements using fewer than 5 years of losses if the 𝐼𝐿𝑀 is greater than 1 and supervisors  believe the losses are representative of the bank’s operational risk exposure.

Operational Risk Capital Requirement

• The operational risk capital requirement is determined by taking into account the 𝐵𝐼𝐶 and the 𝐼𝐿𝑀.

• For banks in bucket 1 of  the previous table (i.e. with 𝐵𝐼  < €1 billion), internal loss data does  not affect the capital calculation. That is, the 𝐼𝐿𝑀  is equal to 1, so that operational risk capital  is equal to the 𝐵𝐼𝐶 (= 12% 𝑋 𝐵𝐼).

• At national discretion, supervisors may allow the inclusion of internal loss data into the  framework for banks in bucket 1, subject to meeting the loss data collection requirements. In  addition, at national discretion, supervisors may set the value of  𝐼𝐿𝑀  equal to 1 for all banks  in their jurisdiction.

• In case this discretion is exercised, banks would still be subject to the full set of disclosure  requirements.

• Minimum operational risk capital (𝑂𝑅𝐶) is calculated by simply multiplying the 𝐵𝐼𝐶 and the 𝐼𝐿𝑀.

Standardized Approach-Application Within A Group

• At the consolidated level, the standardised approach calculations use fully consolidated 𝐵𝐼 figures, which net all the intragroup income and expenses.

• The calculations at a sub-consolidated level use 𝐵𝐼 figures for the banks consolidated at that  particular sub-level. The calculations at the subsidiary level use the 𝐵𝐼 figures from the  subsidiary.

• Similar to bank holding companies, when 𝐵𝐼 figures for sub-consolidated or subsidiary banks  reach bucket 2, these banks are required to use loss experience in the standardised approach  calculations.

• A sub-consolidated bank or a subsidiary bank uses only the losses it has incurred in the  standardised approach calculations (and does not include losses incurred by other parts of the  bank holding company).

• In case a subsidiary of a bank belonging to bucket 2 or higher does not meet the qualitative  standards for the use of the Loss Component, this subsidiary must calculate the standardised approach capital requirements by applying 100%  of  the 𝐵𝐼  Component. In such cases  supervisors may require the bank to apply an 𝐼𝐿𝑀 which is greater than 1.

Min. Standards For Use Of Loss Data Under Standardized Approach

• Banks with a 𝐵𝐼 greater than €1 bn are required to use loss data as a direct input into the  operational risk capital calculations.

• The soundness of data collection and the quality and integrity of the data are crucial to  generating capital outcomes aligned with the bank’s operational loss exposure. National  supervisors should review the quality of banks’ loss data periodically.

• Banks which do not meet the loss data standards are required to hold capital that is at a  minimum equal to 100% of the 𝐵𝐼𝐶. In such cases supervisors may require the bank to apply  an 𝐼𝐿𝑀  which is greater than 1. The exclusion of  internal loss data due to non-compliance  with the loss data standards, and the application of any resulting multipliers, must be publicly  disclosed.

General Criteria On Loss Data Identification, Collection & Treatment

• The proper identification, collection and treatment of internal loss data are essential  prerequisites to capital calculation under the standardised approach. The general criteria for the  use of the 𝐿𝐶 are as follows –
  • Internally generated loss data calculations used for regulatory capital purposes must be  based on a 10-year observation period. When the bank first moves to the standardized  approach, a 5-year observation period is acceptable on an exceptional basis when good-  quality data are unavailable for more than 5 years.
  • Internal loss data are most relevant when clearly linked to a bank’s current business  activities, technological processes and risk management procedures. Therefore, a bank  must have documented procedures and processes for the identification, collection and  treatment of internal loss data. Such procedures and processes must be subject to  validation before the use of the loss data within the operational risk capital requirement  measurement methodology, and to regular independent reviews by internal and/or  external audit functions.
  • For risk management purposes, and to assist in supervisory validation and/or review, a  supervisor may request a bank to map its historical internal loss data into the relevant  Level I supervisory categories as defined in 𝐴𝑛𝑛𝑒𝑥 9 of the Basel II Framework and to  provide this data to supervisors. The bank must document criteria for allocating losses to  the specified event types.
  • A bank’s internal loss data must be comprehensive and capture all material activities and  exposures from all appropriate subsystems and geographic locations. The minimum  threshold for including a loss event in the data collection and calculation of  average  annual losses is set at €20,000. At national discretion, for the purpose of  the calculation  of average annual losses, supervisors may increase the threshold to €100,000 for banks in  buckets 2 and 3 (i.e. where the 𝐵𝐼 is greater than €1 bn).
  • Aside from information on gross loss amounts, the bank must collect information about  the reference dates of operational risk events, including –
    • The date when the event happened or first began (“date of occurrence”)
    • The date on which the bank became aware of the event (“date of discovery”)
    • The date (or dates) when a loss event results in a loss, reserve or provision against a  loss being recognized in the bank’s profit and loss (𝑃&𝐿) accounts (“date of  accounting”)
  • In addition, the bank must collect information on recoveries of gross loss amounts as well  as descriptive information about the drivers or causes of the loss event. The level of detail  of any descriptive information should be commensurate with the size of the loss amount.
    • Operational loss events related to credit risk and that are accounted for in credit risk 𝑅𝑊𝐴s should not be included in the loss data set. Operational loss events that relate to  credit risk, but are not accounted for in credit risk 𝑅𝑊𝐴s should be included in the loss  data set.
    • Operational risk losses related to market risk are treated as operational risk for  the  purposes of calculating minimum regulatory capital under this framework and will  therefore be subject to the standardised approach for operational risk.
    • Banks must have processes to independently review the comprehensiveness and accuracy  of loss data.

Gross Loss, Net Loss And Recovery

• Gross loss is a loss before recoveries of any type.

• Net loss is defined as the loss after taking into account the impact of recoveries.

• The recovery is an independent occurrence, related to the original loss event, separate in time,  in which funds or inflows of economic benefits are received from a third party.

• Banks must be able to identify the gross loss amounts, non-insurance recoveries, and  insurance recoveries for all operational loss events.

• Banks should use losses net of recoveries (including insurance recoveries) in the loss dataset.  However, recoveries can be used to reduce losses only after the bank receives payment.  Receivables do not count as recoveries.

• Verification of payments received to net losses must be provided to  supervisors upon  request.

Computation Of Gross Loss

• Items to be included in the computation of gross loss include –
  • Direct charges, including impairments and settlements, to the bank’s 𝑃&𝐿 accounts and  write-downs due to the operational risk event
  • Costs incurred as a consequence of  the event including external expenses with a direct  link to the operational risk event (e.g., legal expenses directly related to the event and fees  paid to advisors, attorneys or suppliers) and costs of repair or replacement, incurred to  restore the position that was prevailing before the operational risk event
  • Provisions or reserves accounted for in the P&L against the potential operational loss  impact
  • Losses stemming from operational risk events with a definitive financial impact, which are  temporarily booked in transitory and/or suspense accounts and are not yet reflected in  the 𝑃&𝐿 (“pending losses”). Material pending losses should be included in the loss data  set within a time period commensurate with the size and age of the pending item
  • Negative economic impacts booked in a financial accounting period, due to operational  risk events impacting the cash flows or financial statements of previous financial  accounting periods (“timing losses”). Material “timing losses” should be included in the  loss data set when they are due to operational risk events that span more than one  financial accounting period and give rise to legal risk.
• Items that have to be excluded from the computation of gross loss include –
  • Costs of general maintenance contracts on property, plant or equipment
  • Internal or external expenditures to enhance the business after the operational risk losses:  upgrades, improvements, risk assessment initiatives and enhancements
  • Insurance premiums.
• Banks must use the date of accounting for building the loss data set. The bank must use a date  no later than date of accounting for including losses related to legal events in the loss data set.

• For legal loss events, the date of  accounting is the date when a legal reserve is established for  the probable estimated loss in the 𝑃&𝐿.

• Losses caused by a common operational risk event or by related operational risk events over  time, but posted to the accounts over several years, should be allocated to the corresponding  years of the loss database, in line with their accounting treatment.

Exclusion Of Losses From The Loss Component

• Banking organizations may request supervisory approval to exclude certain operational loss  events that are no longer relevant to the banking organization’s risk profile.

• The exclusion of internal loss events should be rare and supported by strong justification. In  evaluating the relevance of operational loss events to the bank’s risk profile, supervisors will  consider whether the cause of the loss event could occur in other areas of  the  bank’s  operations.

• Taking settled legal exposures and divested businesses as examples, supervisors expect the  organization’s analysis to demonstrate that there is no similar or residual legal exposure and  that the excluded loss experience has no relevance to other continuing activities or products.

• The total loss amount and number of exclusions must be disclosed under Pillar 3 with  appropriate narratives, including total loss amount and number of exclusions.

• A request for loss exclusions is subject to a materiality threshold to be set by the supervisor  (for example, the excluded loss event should be greater than 5% of the bank’s average losses).

• In addition, losses can only be excluded after being included in a bank’s operational risk loss  database for a minimum period (for example, three years), to be specified by the supervisor.
• Losses related to divested activities will not be subject to a minimum operational risk loss  database retention period.

Disclosure

• All banks with a 𝐵𝐼 greater than €1 bn, or which use internal loss data in the calculation of  operational risk capital, are required to disclose their annual loss data for each of the ten years  in the 𝐼𝐿𝑀 calculation window.

• This includes banks in jurisdictions that have opted to set 𝐼𝐿𝑀 equal to one. Loss data is  required to be reported on both a gross basis and after recoveries and loss exclusions. All  banks are required to disclose each of the 𝐵𝐼 sub-items for each of the three years of the 𝐵𝐼  component calculation window.