Treatment of direct recoveries under AMA

Can a bank use gross losses net of direct recoveries in modelling for capital purposes under Advanced Measurement Approach for operational risk?

Article 322(2)(a) CRR2 states that an institution shall calculate its own funds requirement under Advanced Measurement Approach as comprising both expected loss and unexpected loss. However the definition of loss is not given. Some guidance in that respect can be found in the Commission Delegated Regulation (EU) 2018/959 – RTS on the specification of the assessment methodology under which competent authorities permit institutions to use Advanced Measurement Approaches for operational risk. This Regulation defines in Article 2(6) “gross loss” (or “loss”) as the loss stemming from an operational risk event before recoveries of any type. The same Regulation distinguishes between ‘gross loss’ or ‘loss’ and ‘calculation data set’, indicating the latter to be used as an input into the operational risk measurement system. Additionally, Article 2(11), while defining “recovery” clearly recognises and differentiates the recoveries from first or third parties. Similar differentiation may be assumed when reading Article 29, which stipulates that an institution cannot use loss net of insurance and ORTM recoveries in the calculation data set. The Article 29 saying nothing about exclusion of direct (non-insurance and non-ORTM recoveries) recoveries from the calculation data set seems therefore to accepts the approach under which the direct recoveries are permitted as a part of the calculation data set and therefore such direct recoveries can be an input to AMA model. At level of global standard setter (i.e. BCBS), the possibility to use direct gross loss after direct recoveries to feed AMA model used for regulatory capital calculation under AMA, seems to be acceptable. For example, it is clearly stated in “Operational Risk – Supervisory Guidelines for the Advanced Measurement Approaches” issued by Basel Committee (BCBS196, para. 24 and repeated in para. 99) that “ A bank may use “gross loss amount” or “gross loss amount after all recoveries (except insurance)” as input for its AMA models. The bank should demonstrate to its relevant supervisors that its choice is appropriate”. Another BCBS document on “Observed range of practice in key elements of Advanced Measurement Approaches (AMA)”, 2009, indicates that “a broad range of practice exists among AMA banks, with most banks (43%) using ‘gross loss after all recoveries (except insurance)’ as the value used for capital quantification”, specifying further that sixty percent of European banks use ‘gross loss after recoveries (except insurance).” This means that an interpretation of AMA requirements in EU which would not permit the use of direct recoveries (except insurance) in banks operating in EU might lead to situation where banks operate under inconsistent rules, which would be against the Single Rulebook and level playing field principles governing in EU.