5.18 The PRA proposed to exercise the national discretion included in the Basel 3.1 standards to set the ILM equal to 1 to remove the mechanical link to historical internal operational risk losses.

5.19 Twenty respondents were supportive of the proposal, with one respondent also suggesting the PRA should consider allowing firms to adjust Pillar 2A based on a variable ILM. One respondent did not support the proposals, arguing this is a blunt approach and not in line with the risk-based approach of other capital requirements. The respondent argued that the proposal would disproportionately penalise firms that have not incurred operational losses above the market average.

5.20 Having considered the responses, the PRA has decided to maintain its proposal to set the ILM equal to 1, exercising the national discretion in the Basel 3.1 standards. The PRA acknowledges that historical losses can provide some important information when considering operational risk. However, as set out in CP16/22, the PRA considers that a mechanical link to past losses is inappropriate for a number of reasons, including that the 'fat-tailed' nature of operational risk losses - being infrequent but very large - means past events (particularly over a lengthy historical period) are generally not good predictors of future losses. The PRA will continue to use its more flexible Pillar 2A methodology, which applies supervisory judgement when considering the relevance of past losses to future exposure to operational risk.

PRA objectives and 'have regards' analysis