Operational risk capital frequently asked questions

The treatment of the regulatory line items in ARF 115.0 follows the Basel specification of these items. The Basel treatment recognises the difference between operational risk for which there is no fundamental measure of exposure and other risk types, such as credit risk and market risk, which have well-defined fundamental measures of exposure, such as a facility for credit risk and a transaction for market risk. 

While individual processes (such as payment processing) could be considered as operational risk exposure measures, they do not provide a feasible and stable map to operational risks which is mutually exclusive and collectively exhaustive. This is due to the large number of processes in an ADI, which are often changing and are subject to multiple risks, such as execution failure or internal fraud for payments and mis-selling or compliance for product distribution. 

Hence, an ADI’s operational risk exposure must be estimated indirectly. The Standardised Measurement Approach uses a financial proxy to estimate operational risk exposure and associated regulatory capital. Accordingly, the use of the line items, such as Other Operating Expenses, focuses on the components relevant to estimating operational risk exposure. Hence, the regulatory line items are aimed at a different purpose from financial accounting and so will sometimes differ.

References:

• ARS 115.0 paragraph 12
• APS 310 paragraph 36

APRA does not expect an ADI to have audited year-end financial statements at Level 1 and Level 2 in order to comply with the requirements of ARS 115.0 paragraph 12. However, an ADI is expected to be able to evidence, if required, that an external auditor has conducted the review and testing under paragraph 12 and that the review and testing is sufficiently frequent   to enable the auditor to form an opinion on the accuracy and reliability of the information provided by the ADI. An ADI is expected to apply reasonable assumptions and processes to produce the items in the reporting standard. A review of these assumptions and processes must form part of the external auditor’s review and testing, with reasonable assurance to be provided for data sourced only from accounting records and limited assurance for other data, including data from non-accounting records, in accordance with APS 310 paragraph 36.

References:

• ARS 115.0 paragraph 5 to 6, 12 to 13
• APS 310 paragraph 36

APRA expects ADIs to use reasonable endeavours and clearly defined and documented processes to report the required information in ARF 115.0 at Level 1 and Level 2 similarly to other reporting standards such as ARS 110.0 Capital Adequacy. 

In circumstances where the information is not available at Level 1 and Level 2, ADIs may consider reasonable approximations to or assumptions for determining the required information. In the absence of a more accurate approximation, this may include apportioning a total figure to Level 1 and Level 2 based on the proportions of another relevant item available at Level 1 and Level 2. 

APRA expects ADIs to document any assumptions and relevant business rules used.  These should be based on annual audited financial statements and form part of the external auditor’s assurance review and testing . Reasonable assurance is to be provided for data sourced only from accounting records and limited assurance for other data, including data from non-accounting records, in accordance with paragraph 36 of APS 310.

References:

• APS 330 paragraph 4, 15
• APS 330 Attachment C, Table 3 item 1(d)

Entities should continue to publicly disclose the information specified under the current APS 330 paragraphs 4 and 15. APRA is considering whether further information should be publicly disclosed under revisions to APS 330 in relation to the information provided under ARS 115.0.  

References:

• ARS 115.0 paragraph 5
• ARS 115.0 Instruction Guide, Definitions: Dividend income

Yes. Although capital is required to be held by a parent entity against the equity investment in a subsidiary, it is possible for the parent entity to incur operational risk losses from the business activities of the subsidiary in addition to this amount of capital held. Hence, operational risk capital needs to be held at Level 1 for such a circumstance.

References:

• ARS 115.0 Instruction Guide, Definitions: Dividend income
• APS 001, Attachment B, Non-consolidated subsidiaries

The dividend income that should be included in Level 2 reporting is the dividend income of the Level 2 entity 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.

References:

• APS 115 paragraph 17
• ARS 115.0 Instruction Guide, Definitions: Interest-earning assets
• ARS 115.0 Instruction Guide, Definitions: Loans and advances

Impaired loans are expected to be included in ‘Loans and Advances’, whereas provisions are not expected to be deducted. This is consistent with the use of total gross outstanding loans (including non-performing loans) as the basis of an ADI’s asset component in paragraph 17 of APS 115.

References:

• ARS 115.0 Instruction Guide, Definitions: Other operating income, Other operating expense

The gain or loss of the sale of a lease business should be included in the Other Operating Income or Other Operating Expense category.

References:

• APS 115 paragraph 19(b), 23
• ARS 115.0 Instruction Guide, Exclusions 
• ARS 115.0 Instruction Guide, Definition: Other operating expenses

No.

No.