Recommendation for the determination of the relevant indicator

Section 271 of the Solvency Ordinance (as of 01.01.2007)
Definition of the relevant indicator
(1) The relevant indicator shall be calculated by institutions on the basis of the following items pursuant to the Bank Accounting Ordinance (Verordnung über die Rechnungslegung der Kreditinstitute und Finanzdienstleistungsinstitute / RechKredV ), with income items being added and expense items being subtracted:

1. interest receivable and similar income,

2. interest payable and similar charges,

3. income from shares and other variable/fixed-yield securities,

4. commissions/fees receivable,

5. commissions/fees payable,

6. net profit or net loss on financial operations and

7. other operating income (including leasing result).

(2) 1The following items shall be disregarded when calculating the relevant indicator even if they are included in the items under subsection (1):

1. income from extraordinary or irregular items,

2. realised profits/losses from the sale of non-trading book items, and

3. income derived from insurance.

2This shall be documented appropriately.

(3) If revaluation of trading book items is booked in the profit and loss statement, revaluation shall be included.

(4) Expenditure on the outsourcing of services rendered by third parties may reduce the relevant indicator only if said expenditure is paid to group enterprises pursuant to section 10a of the German Banking Act (KWG) or from enterprises subject to equivalent supervision.

(5) 1Institutions which prepare their annual financial statements using the International Financial Accounting Standards shall calculate the relevant indicator in a way that best reflect the definition in subsection (1). 2 Subsections (2) to (4) shall be applied as appropriate. 3The same shall apply to calculation on a consolidated basis. 4The consolidation scope for which the capital requirement for operational risk is calculated may correspond to the accounting framework used and, to that extent, deviate from the consolidation scope pursuant to section 10a of the German Banking Act if plausible evidence is given that this does not materially reduce the relevant indicator.

(6) 1Building societies with saving facilities may include only the respective items in the saving facilities when calculating the relevant indicator. 2The derivation of the income and expenses of the saving facilities from the accounting records shall be documented appropriately.

Explanatory comments (as of 31.10.2007)

Re subsection (1):
The P&L items listed are to be determined in accordance with Form 2 or 3 of the Bank Accounting Ordinance (RechKredV). The basis of the calculations shall be the audited annual financial statements. When no audited figures are available, internal estimates of the as yet unaudited annual account figures may also be used (section 270 (2) and section 273 (1) of the Solvency Ordinance). Even if there is any change in the scope of business activities, e.g. as a result of mergers or disposals of parts of the business, for the purposes of the calculation of regulatory capital no subsequent adjustments of the annual values must be made, save for the setting of special ratios pursuant to section 10 (1b) indents (a) and (b) of the German Banking Act.

For the purpose of determining the relevant indicator pursuant to the Bank Accounting Ordinance (RechKredV), as a matter of general principle the gross principle applying there should be observed. The indicator shall be calculated before the deduction of any provisions and -operating expenses. For leasing business, however, the sum of revenues from leasing contracts minus the regular depreciation of these leased assets and the service agreement expenditure directly attributable to these leasing contracts (net leasing income) is included in the relevant indicator. Leasing business risk provisioning must not be deducted when determining the relevant indicator.

In general, leasing business is not subject to any higher operational risks than comparable lending business, so in that respect a higher capital requirement for operational risk is not justified. This would, however, be the result if revenues from leasing business had to be considered in gross income without depreciation on the leased assets and any service agreements being allowed to be recognised. For that reason net leasing income can be used for determining the relevant indicator.
Income from interests in a company, even if they derive from shares, are not included in the calculation of the relevant indicator.

Re subscetion (2):
If income is booked as extraordinary income, it is not included in the relevant indicator.

As a matter of general principle, there should be identity between the figures of the individual relevant indicator items and the corresponding profit and loss statement items. No adjustment can be made to these values except in the cases provided for in section 271 (2) and (4). In particular cases, institutions may choose not to take immaterial extraordinary or irregular income out of the calculation of the relevant indicator if any such adjustment of the P&L items would be too complex.

Irregular income is as a matter of general principle deemed to be income that does not arise in the regular course of business. In considering whether income is irregular, strict criteria should be applied. The objective of this rule is to prevent the relevant indicator being significantly distorted and overstated by such income.

Irregular income includes the writeback of excessively high risk provisions and the receipt of insurance benefits, especially on buildings insurance. The reimbursement of administrative expenditure, if recorded as other operating income, is not to be deducted from the value of the relevant indicator; only refunds of advance tax payments may be deducted.

Insurance can be employed in risk management in order to transfer operational risk. However, in the simple approaches this does not result in a reduction of the relevant indicator. Insurance payments on account of loss or damage are not to be included in the relevant indicator.

The capital requirement would also be overstated in case of risk provisions written back to income. This increases the relevant indicator, while the creation of provisions does not reduce it. This should be avoided in order to allow appropriate provisioning without causing an additional capital burden arising merely due to conservative provisioning but not due to an increased risk situation. For that reason income from the release of risk provisions has to be regarded as irregular income and is therefore not included in the relevant indicator. Income from the release of provisions for interest and commissions/fees should, however, be recognised in the relevant indicator.

Income (and expenditure) arising from insurance business should not be included in the determination of the relevant indicator since insurance business is subject to the requirements of the Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG) and additional banking supervision requirements are therefore not necessary. On the other hand, commission income from the broking of insurance contracts by institutions should be taken into account in the determination of the relevant indicator. Income from refunds of insurance premiums is included in the relevant indicator and is not to be regarded as irregular income.

Re subsection (4):
Expenditure on the outsourcing of activities may reduce the relevant indicator only if this expenditure is incurred in respect of consolidated enterprises as defined by section 10a of the German Banking Act (KWG) or of enterprises subject to equivalent supervision. These include both institutions and other enterprises for which there exists an operational risk capital requirement that is measured in accordance with standards that are equivalent to the Solvency Ordinance individually or within a group of institutions or a financial holding group. Equivalent supervision standards exist in the Member States of the European Union and European Economic Area. Payments for outsourcing to companies in countries outside these regions may be deducted only after clearance from BaFin. For this purpose the institution must furnish proof that the company is subject to equivalent supervision by a public authority.

Re subsection (5):
Institutions or financial holding groups and groups of institutions may prepare their annual accounts using an accounting framework, in derogation from EU Directive 86/635/EC, other than the Bank Accounting Regulation. This also applies in an appropriate form for the determination of the relevant indicator.

For institutions which do prepare their annual accounts using an accounting framework in derogation from EU Directive 86/635/EC, the relevant indicator should be calculated on a basis that best reflects the definition in subsection (1).This rule relates to individual profit and loss items. The principle of identity of positions applies in this case, too. There is no need to carry out an additional valuation of the underlying items in accordance with the provisions of the Bank Accounting Regulation, e.g. when revaluing trading book positions which are subject to different valuation rules under the Bank Accounting Regulation and IAS. The rules underlying the accounting standard actually used should be observed. For that reason, in particular cases items or entries may have to be recorded as income under the Bank Accounting Regulation and can be recorded as adjustments in expenditure under other standards; the corresponding figures shown in the profit and loss statement are to be used for determining the relevant indicator.

When the costs of company-produced additions to plant and equipment are capitalised, this is as a matter of principle to be regarded as reducing expenditure; if they are taken to income, they may if necessary be deducted from the relevant indicator as irregular income.

If an institution or group of institution prepares the P&L on the basis of the CEBS Framework for Consolidated Financial Reporting, the relevant indicator is to be determined on the basis of the following consolidated income statement items, with income being added and expenditure being deducted:

1. interest Income

2. interest Expenses

3. dividend Income

4. fee and commission income

5. fee and commission expenses

6. gains/losses on financial assets and liabilities held for trading, net

7. exchange differences, net

8. gains/losses from hedge accounting, net

9. other operating income

If an institution or group of institutions changes the accounting standard according to which it prepares its annual accounts for the purpose of calculating the three-year average for the relevant indicator the transition may be staggered, i.e. in the transition period annual account figures calculated according to, for instance, the Bank Accounting Regulation and IFRS can be mixed. There is no need to make retroactive adjustments for previous years.

When dealing with consolidated figures, either the consolidation definition pursuant to section 10a of the Banking Act or that defined by the accounting standard used should be used. For assessing whether the relevant indicator is materially reduced by the use of another consolidation definition, a particularly close analysis should be made to determine which institutions or undertakings from the consolidation definition pursuant to section 10a are omitted and what effect this has on the relevant indicator. If calculating the relevant indicator for these enterprises would be unduly costly, this assessment may alternatively be based on the profit for the year before depreciation and personnel and non-personnel expenses. The deviation must not be material in the light of the risks existing in these undertakings.

Re subsection (6):
When deriving the relevant indicator, building societies with saving facilities should proceed in accordance with subsection (5); only items concerning the saving facilities should be included in the calculation.