What the latest Basel 3.1 update means for operational risk

On 12th September, The Prudential Regulation Authority (PRA) released its much anticipated second set of Basel 3.1 rules. While there were no new material changes to the Operational Risk Capital calculation initially released in December 2023, there were some important changes and clarifications to Operational Risk reporting and disclosures.

We’ve already written a general summary covering the main changes and implications of the latest Basel 3.1 update, as well as a deep dive on Credit Risk and Market Risk. In this blog, we’ll take a closer look at what it means for those working in operational risk, and what you need to do next.

Why is Basel 3.1 relevant to operational risk?

Simply put, Basel 3.1 brings an overhaul to Pillar 1 Capital Calculation for Operational Risk Capital (ORC), with the aim of simplifying and standardising the approach — therefore making ORC comparable between lenders.

In general, we’re expecting Pillar 1 ORC to increase for lenders, with larger lenders potentially impacted the most. It’s also worth noting that the PRA has said it’s prepared to mechanically alter Pillar 2 ORC to ensure total ORC does not significantly change due to Basel 3.1.

For Interim Capital Regime (ICR) firms, Basel 3.1 is yet to detail any changes to Operational Risk calculations. That means these firms will continue to operate under existing rules until the permanent risk-based capital framework for Small Domestic Deposit Takers (SDDTs) is implemented.

For everyone else, all existing approved calculations are being removed and a single new Standardised Approach (SA) is being introduced.

What does the latest Basel 3.1 update mean for operational risk?

The main thing to note is that the PRA will exercise its national discretion by setting the Internal Loss Multiplier (ILM) to 1, thereby removing historical loss from the calculation of Pillar 1 ORC. Overall, this decision has been welcomed by the industry — including UK Finance and the BSA.

The ILM looks at ten years of historical operational loss to give a scale factor adjustment to ORC. With the PRA setting the ILM to 1, there is no historical loss element to the calculation, enabling comparison between lenders. However, lenders will still need to calculate their ILM for reporting to the PRA as part of the new reporting requirements and templates.

All important changes to note from the PRA’s update:

1. All existing calculations are being replaced by a new SA.
2. The Business Indicator Component has a marginal coefficient, hitting larger firms harder.
3. ILM is being set to 1, removing historic losses from the calculation.
4. There are significant data gathering and governance requirements to be aware of.
5. The PRA is expecting minimal change to total Pillar 1 + Pillar 2 Capital (although there isn’t much detail on how the PRA is planning to achieve this).
6. For ICR firms, 3.1 brings no change.

What does that mean for me?

For anyone working in operational risk, the PRA’s latest update on Basel 3.1 means that the approach outlined in December PS 17/23 still applies. The main difference to note is the delayed start date of 1st January 2026. 

Hopefully, you’ll already have prepared your approach, meaning formal implementation and testing can proceed as planned.

Basel 3.1 and operational risk — our thoughts?

Applying a single formula brings in welcomed consistency and comparability to Pillar 1 ORC, although this does come at the expense of flexibility. Utilising the PRA’s national discretion to set the ILM to 1, while still requiring the figure to be reported, shifts the focus from the ORC calculation to the underlying data.

Strong governance and robust data gathering processes are therefore paramount. If you need support, then we’d recommend starting with 4most’s latest guide on replacing EUCs — where we explore the regulatory dangers of critical manual processes, and the operational benefits of replacing them.

What’s next?

For more guidance, you can read our general summary of the latest Basel 3.1 update, as well as what it means for…

• Credit Risk
• Market Risk

To find out how 4most can help your business respond to the Operational Risk implications of Basel 3.1, complete our short contact form, and we’ll get straight back to you.