Operational risk

Part

BIPRU Prudential sourcebook for Banks, Building Societies and Investment Firms

Chapter

Operational risk

Printed on: 13/11/2024

Rulebook at: 06/07/2007

BIPRU 6

Operational risk

BIPRU 6.1

Operational risk: Application and purpose

01/01/2007

Application

BIPRU 6.1.1

BIPRU 6 applies to a BIPRU firm except for:

(1) a BIPRU limited licence firm; and
(2) a BIPRU limited activity firm.

01/01/2007

BIPRU 6.1.2

A BIPRU limited licence firm or BIPRU limited activity firm that wishes to calculate an operational risk capital requirement in accordance with this chapter for the purposes of its capital resources requirement should apply for a waiver to modify GENPRU 1.1 or seek a variation to its permission so that it is treated as a full scope BIPRU investment firm.

01/01/2007

Purpose

BIPRU 6.1.3

The purpose of BIPRU 6 is:

(1) to detail the requirement to hold capital to cover operational risk losses and have appropriate systems and controls in place to manage operational risk; and
(2) to explain how to calculate the operational risk capital requirement, or ORCR.

01/01/2007

BIPRU 6.1.4

BIPRU 6 implements:

(1) Articles 102 to 104;
(2) Article 105, in part; and
(3) Annex X;

of the Banking Consolidation Directive.

01/01/2007

BIPRU 6.2

Operational risk: Methodologies and systems

01/01/2007

The definition of ORCR

BIPRU 6.2.1

The operational risk capital requirement (ORCR) for a firm is an amount calculated in accordance with:

(1) the basic indicator approach (see BIPRU 6.3); or
(2) the standardised approach (see BIPRU 6.4).

[Note: BCD Article 102(1)]

01/01/2007

BIPRU 6.2.2

The simplest method of calculating the ORCR is the basic indicator approach and a firm should use this approach if it does not, or is not permitted to, use another approach.

01/01/2007

BIPRU 6.2.3

A firm does not need a waiver to use the standardised approach. However there are eligibility conditions that a firm should satisfy if it is to use this approach. If it does not satisfy them, it should not use this approach.

01/01/2007

BIPRU 6.2.4

A firm may apply to the FSA for a waiver from BIPRU 6.2.1 R in order to use its own advanced measurement approach for the calculation of its ORCR (see BIPRU 6.5). If the waiver is granted, the ORCR will be an amount determined in accordance with such waiver.

[Note: BCD Article 105(1)]

01/01/2007

Restrictions on changing the approach used for calculating ORCR

BIPRU 6.2.5

A firm that calculates its ORCR using the standardised approach must not change to calculating its ORCR using the basic indicator approach.

[Note: BCD Article 102(2) (part)]

01/01/2007

BIPRU 6.2.6

A firm may apply to the FSA for a waiver from BIPRU 6.2.5 R where it can demonstrate good cause for changing to the basic indicator approach.

[Note: BCD Article 102(2) (part)]

01/01/2007

BIPRU 6.2.7

[to follow]

01/01/2007

BIPRU 6.2.8

A firm may apply to the FSA for a waiver from BIPRU 6.2.7 R where it can demonstrate good cause for changing to the standardised approach or the basic indicator approach as the case may be.

[Note: BCD Article 102(3) (part)]

01/01/2007

Combination of different methodologies

BIPRU 6.2.9

[to follow]

01/01/2007

BIPRU 6.2.10

Where a firm's AMA permission allows it to use an advanced measurement approach in combination with either the basic indicator approach or the standardised approach, the FSA may impose additional conditions on a case by case basis as follows:

(1) on the date of implementation of an advanced measurement approach, a significant part of the firm's operational risks are captured by the advanced measurement approach; and
(2) the firm is obliged to roll out the advanced measurement approach to a material part of its operations within a time schedule set out in its AMA permission.

[Note: BCD Annex X, Part 4 point 2]

01/01/2007

BIPRU 6.2.11

A firm applying for an AMA permission to use a combination of different approaches must be able to show that:

(1) at the date of implementation of the advanced measurement approach, approximately 50% (or more) of the firm's operational risk is captured under the AMA; and
(2) the firm has committed to roll out the advanced measurement approach for around 85% (or more) of its operational risk, subject to the remaining percentage not being concentrated in a single operation, within a timescale set out in the AMA permission.

01/01/2007

BIPRU 6.2.12

For the determination of its ORCR, a firm must not use any of the following combinations of methodologies:

(1) the basic indicator approach with the standardised approach;
(2) the basic indicator approach with the alternative standardised approach; or
(3) the standardised approach with the alternative standardised approach for the same business line.

01/01/2007

BIPRU 6.2.13

A firm may apply to the FSA for a waiver from BIPRU 6.2.12 R (1) and BIPRU 6.2.12 R (2) in exceptional circumstances, such as the recent acquisition of new business, which require a transition period for the roll out of the standardised approach (or the alternative standardised approach). In this event, a firm will need to make a commitment to roll out the standardised approach (or the alternative standardised approach) within a time schedule agreed with the FSA.

[Note: BCD Annex X, Part 4 points 3 and 4]

01/01/2007

BIPRU 6.3

Operational risk: Basic indicator approach

01/01/2007

ORCR

BIPRU 6.3.1

The ORCR under the basic indicator approach is equal to 15% of the relevant indicator defined in this section.

[Note: BCD Article 103 and Annex X, Part 1 point 1]

01/01/2007

Relevant indicator: General

BIPRU 6.3.2

(1) The relevant indicator is the three-year average of the sum of:

(a) a firm's net interest income; and
(b) a firm's net non-interest income.

(2) The three-year average must be calculated on the basis of the last three yearly observations at the end of the financial year. When audited figures are not available, business estimates may be used.
(3) If for any given observation, the sum of a firm's net interest income and net non-interest income is negative or equal to zero, this figure must be excluded from both the numerator and denominator when calculating the three year average. The relevant indicator must be calculated as the sum of the positive figures divided by the number of positive figures.

[Note: BCD Annex X, Part 1 points 2 to 4]

01/01/2007

Relevant indicator: An example calculation

BIPRU 6.3.3

If a firm has:

(1) two positive yearly relevant indicators of £20 each; and
(2) the final yearly observation shows a negative figure of £5; then

the relevant indicator is calculated as £20, being £40 (sum of positive figures) divided by 2 (number of positive figures).

01/01/2007

Relevant indicator: Insufficient income data

BIPRU 6.3.4

A firm that does not have sufficient income data to meet the three-year requirement (e.g. a start-up) may use its forecasted gross income projections for all or part of the three year time period when calculating its relevant indicator.

01/01/2007

Relevant indicator: Application of accounting categories

BIPRU 6.3.5

(1) This rule applies to a firm that is subject to the Bank Accounts Directive.
(2) Based on accounting categories for the profit and loss account of credit institutions under Article 27 of the Bank Accounts Directive, the relevant indicator in BIPRU 6.3.2 R must be expressed as the sum of the elements listed in the table in BIPRU 6.3.6 R.
(3) Each element in the table in BIPRU 6.3.6 R must be included in the sum with its positive or negative sign.

[Note: BCD Annex X, Part 1 point 5]

01/01/2007

BIPRU 6.3.6

Table: Relevant indicators This table belongs to BIPRU 6.3.5 R

Interest receivable and similar income

Interest payable and similar charges

Income from shares and other variable/fixed-yield securities.

Commissions/fees receivable

Commission/fees payable

Net profit or net loss on financial operations

Other operating income

01/01/2007

BIPRU 6.3.7

Income from a participation held in an undertaking by the firm or a subsidiary undertaking of the firm should not be included in the relevant indicator calculations, to ensure that intra-group dividends and other intra-group income flows are not double counted.

01/01/2007

BIPRU 6.3.8

Income received under an operating lease should be included as gross income less depreciation, not as gross rental income.

01/01/2007

BIPRU 6.3.9

(1) If a firm considers that, due to exceptional circumstances, using a three year average to calculate the relevant indicator would lead to a major overestimation of its ORCR, the firm may apply for a waiver from BIPRU 6.3.2 R.
(2) Exceptional circumstances might include stopping or selling a major business line.

01/01/2007

Qualifications

BIPRU 6.3.10

(1) The relevant indicator for the basic indicator approach must be calculated before the deduction of any provisions and operating expenses.
(2) Operating expenses must include fees paid for outsourcing services rendered by third parties which are not a parent undertaking or subsidiary undertaking of the firm or a subsidiary undertaking of a parent undertaking which is also the parent undertaking of the firm. Expenditure on the outsourcing of services rendered by third parties may reduce the relevant indicator if the expenditure is incurred by an undertaking subject to supervision under, or equivalent to, the Banking Consolidation Directive.

[Note: BCD Annex X, Part 1 point 7]

01/01/2007

BIPRU 6.3.11

The definition of 'outsourcing' for the purposes of BIPRU 6.3.10 R (2) is set out in detail in a Joint Forum paper of the Basel Committee on Banking Supervision entitled "Outsourcing in Financial Services" dated February 2005 and can be summarised as meaning a firm's use of a third party to perform activities on a continuing basis that would normally be undertaken by the firm, now or in the future and can be the initial transfer of an activity (or part of that activity) from the firm to a third party or a further transfer of an activity (or part thereof) from one third party service provider to another.

01/01/2007

BIPRU 6.3.12

The following elements must not be used in the calculation of the relevant indicator:

(1) realised profits/losses from the sale of non-trading book items;
(2) income from extraordinary or irregular items; and
(3) income derived from insurance.

[Note: BCD Annex X, Part 1 point 8 (part)]

01/01/2007

BIPRU 6.3.13

When revaluation of trading items is part of the profit and loss statement, revaluation may be included in the calculation of the relevant indicator.

[Note: BCD Annex X, Part 1 point 8 (part)]

01/01/2007

BIPRU 6.3.14

When Article 36(2) of the Bank Accounts Directive is applied, revaluation booked in the profit and loss account must be included in the calculation of the relevant indicator.

[Note: BCD Annex X, Part 1 point 8 (part)]

01/01/2007

BIPRU 6.3.15

When a firm is subject to an accounting framework different from the one established by the Bank Accounts Directive, it must calculate the relevant income indicator on the basis of internal data that best reflect the definition in this section.

[Note: BCD Annex X, Part 1 points 6 and 9]

01/01/2007

General risk management standards

BIPRU 6.3.16

In common with all BIPRU firms, a firm calculating its ORCR using the basic indicator approach is required to meet the general risk management standards set out in SYSC 4.1.1 R to SYSC 4.1.2 R and SYSC 7.1.16 R.

06/04/2007

BIPRU 6.4

Operational risk: Standardised approach

01/01/2007

Eligibility

BIPRU 6.4.1

(1) To be eligible for the standardised approach, a firm must meet the qualifying criteria set out in this rule, in addition to the general risk management standards set out in SYSC 4.1.1 R to SYSC 4.1.2 R and SYSC 7.1.16 R .
(2) A firm must have a well-documented assessment and management system for operational risk with clear responsibilities for the system assigned within the firm. The system must identify the firm's exposures to operational risk and track relevant operational risk data, including material loss data.
(3) A firm's operational risk assessment and management system must be subject to regular independent review.
(4) A firm's operational risk assessment system must be closely integrated into the firm's risk management processes. Its output must be an integral part of the process of monitoring and controlling the firm's operational risk profile.
(5) A firm must implement a system of management reporting that provides operational risk reports to relevant functions within the firm. A firm must have procedures in place for taking appropriate action in response to the information contained in such reports.

[Note: BCD Article 104(6) and Annex X, Part 2 point 12 (part)]

06/04/2007

BIPRU 6.4.2

A firm must comply with the criteria in BIPRU 6.4.1 R having regard to the size and scale of its activities and to the principle of proportionality.

[Note: BCD Annex X, Part 2 point 12 (part)]

01/01/2007

Business lines

BIPRU 6.4.3

Under the standardised approach, a firm must divide its activities into a number of business lines as set out in this section.

[Note: BCD Article 104(1)]

01/01/2007

BIPRU 6.4.4

The list of activities in BIPRU 6.4.15 R is not a complete definition of the activities within a business line and it may be possible for an activity to be allocated to a business line other than the one to which it is attributed in BIPRU 6.4.15 R.

01/01/2007

BIPRU 6.4.5

For each business line, a firm must calculate a capital requirement for operational risk as a certain percentage of a relevant indicator, in accordance with the rules in this section.

[Note: BCD Article 104(2)]

01/01/2007

ORCR calculated using the standardised approach

BIPRU 6.4.6

The ORCR under the standardised approach is the average over three years of the risk weighted relevant indicators calculated each year across the business lines in BIPRU 6.4.15 R.

[Note: BCD Annex X, Part 2 point 1 (part)]

01/01/2007

BIPRU 6.4.7

In each year, a negative capital requirement in one business line, resulting from a negative relevant indicator, may be imputed to the whole. However, where the aggregate capital charge across all business lines within a given year is negative, then the input to the average for that year must be zero.

[Note: BCD Annex X, Part 2 point 1 (part)]

01/01/2007

BIPRU 6.4.8

(1) If a firm considers that, due to exceptional circumstances, using a three year average to calculate the relevant indicator would lead to a major overestimation of its ORCR, the firm may apply for a waiver from BIPRU 6.4.5 R.
(2) Exceptional circumstances might include stopping or selling a major business line.

01/01/2007

Relevant indicator

BIPRU 6.4.9

The three year average in BIPRU 6.4.6 R must be calculated on the basis of the last three twelve monthly observations at the end of the financial year. When audited figures are not available, business estimates may be used.

[Note: BCD Annex X, Part 2 point 2]

01/01/2007

Principles for business line mapping

BIPRU 6.4.10

A firm must develop and document specific policies and criteria for mapping the relevant indicator for current business lines and activities into the framework for the standardised approach. The criteria must be reviewed and adjusted for new or changing business activities and risks as appropriate.

[Note: BCD Annex X, Part 2 point 4 (part)]

01/01/2007

BIPRU 6.4.11

(1) The principles for business line mapping that a firm must meet are set out in this rule.
(2) All activities must be mapped into the business lines in a mutually exclusive and jointly exhaustive manner.
(3) Any activity which cannot be readily mapped into the business line framework, but which represents an ancillary function to an activity included in the framework, must be allocated to the business line it supports. If more than one business line is supported through the ancillary activity, an objective mapping criterion must be used (e.g., proportional allocation of the indicators).
(4) If an activity cannot be mapped into a particular business line then the business line yielding the highest charge for the firm must be used. The same business line equally applies to any associated ancillary activity.
(5) A firm may use internal pricing methods to allocate the relevant indicator between business lines.
(6) The mapping of activities into business lines for operational risk capital purposes must be consistent with the definitions of business lines used by the firm for credit and market risks.
(7) Senior management must be responsible for the mapping policy.
(8) The mapping process to business lines must be subject to independent review.

[Note: BCD Annex X, Part 2 point 4 (part)]

01/01/2007

BIPRU 6.4.12

A firm that is mapping activities to a business line should take into account:

(1) the activities listed in respect of each business line in the table in BIPRU 6.4.15 R; and
(2) the organisation of the firm's business in respect of that business line.

01/01/2007

BIPRU 6.4.13

A firm should take into account its business and organisation when mapping activities to the business lines in the table in BIPRU 6.4.15 R.

01/01/2007

BIPRU 6.4.14

For the purposes of BIPRU 6.4.11 R (5), costs generated in one business line which are imputable to a different business line may be reallocated to the business line to which they pertain, for instance by using a treatment based on internal transfer costs between two business lines.

[Note: BCD Annex X, Part 2 point 4 (part)]

01/01/2007

BIPRU 6.4.15

Table: Percentages applying to the income indicator of individual business lines
This table belongs to BIPRU 6.4.3 R

Business line

List of activities

Percentage

Corporate finance

•Underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis

•Services related to underwriting

•Investment advice

•Advice to undertakings on capital structure, industrial strategy and related matters and advice and services relating to the mergers and the purchase of undertakings

•Investment research and financial analysis and other forms of general recommendation relating to transactions in financial instruments

18%

Trading and sales

•Dealing on own account

•Money broking

•Reception and transmission of orders in relation to one or more financial instruments

•Execution of orders on behalf of clients

•Placing of financial instruments on a best efforts basis

•Operation of multilateral trading facilities

18%

Retail brokerage
(Activities with individual physical persons or with a retail SME as defined under the standardised approach to credit risk)

•Reception and transmission of orders in relation to one or more financial instruments

•Execution of orders of behalf of clients

•Placing of financial instruments without a firm commitment basis

12%

Commercial banking

•Acceptance of deposits and other repayable funds

•Lending

•Financial leasing

•Guarantees and commitments

15%

Retail banking
(Activities with an individual physical persons or with a retail SME as defined under the standardised approach to credit risk)

•Acceptance of deposits and other repayable funds

•Lending

•Financial leasing

•Guarantees and commitments

12%

Payment and settlement

•Money transmission services

•Issuing and administering means of payment

18%

Agency services

•Safekeeping and administration of financial instruments for the account of clients including custodianship and related services such as cash/collateral management

15%

Asset management

•Portfolio management

•UCITS management and other forms of asset management

12%

01/01/2007

The alternative standardised approach

BIPRU 6.4.16

Under the alternative standardised approach, a firm using the standardised approach may use alternative indicators for retail banking and commercial banking business lines if it complies with BIPRU 6.4.17 R to BIPRU 6.4.21 R.

[Note: BCD Annex X, Part 2 point 3]

01/01/2007

Eligibility for the alternative standardised approach

BIPRU 6.4.17

To be eligible to use the alternative standardised approach, a firm must meet the following conditions, in addition to the general risk management standards set out in SYSC 4.1.1 R to SYSC 4.1.2 R and SYSC 7.1.16 R :

(1) the firm must meet the eligibility criteria for the standardised approach in BIPRU 6.4.1 R;
(2) the firm must be overwhelmingly active in retail and/or commercial banking activities, which must account for at least 90% of its income; and
(3) the firm must be able to demonstrate that a significant proportion of its retail and/or commercial banking activities comprise loans associated with a high probability of default, and that the alternative standardised approach provides an improved basis for assessing the operational risk.

[Note: BCD Article 104(3) and Annex X, Part 2 points 5 and 8 to 11]

06/04/2007

BIPRU 6.4.18

In relation to BIPRU 6.4.17 R (3), the FSA's view is that a high probability of default is equal to or greater than 3.5%.

01/01/2007

ORCR calculated using the alternative standardised approach

BIPRU 6.4.19

(1) The relevant indicators under the alternative standardised approach are the same as for the standardised approach except for the two following business lines:

(a) retail banking; and
(b) commercial banking.

(2) For retail banking and commercial banking, the ORCR must be calculated as a normalised income indicator equal to the three-year average of the total nominal amount of loans and advances multiplied:

(a) by 0.035, and then
(b) by the appropriate business line percentage set out in BIPRU 6.4.15 R.

[Note: BCD Annex X, Part 2 point 6]

01/01/2007

BIPRU 6.4.20

For the retail and/or commercial banking business lines, the loans and advances must consist of the total drawn amounts in the corresponding credit portfolios.

[Note: BCD Annex X, Part 2 point 7 (part)]

01/01/2007

BIPRU 6.4.21

For the commercial banking business line, the securities held in the non-trading book must also be included.

[Note: BCD Annex X, Part 2 point 7 (part)]

01/01/2007