Clarifications on the definition of legal risk

As defined by Basel 2, all court actions where the subject is defendant are classified amongst the elements of legal risk in addition to ones aimed at collecting incurred operational losses where the subject is the plaintiff. Legal proceedings initiated by the bank for debt collection are not covered in the following analysis.

General Criteria

♦ Survey on the first Gross Actual Loss flow (for example, initial legal expenses or initial provision).

♦ The loss forecast shall be reported to DIPO only when it generates the need for a provision according to accounting criteria. The value communicated by the legal department shall be recorded as a provision amount, before its discounting for IAS purposes.

♦ Shall the provisions flag be set on ‘YES’, this will mean that there is a provision element.

♦ The event shall remain open until the definitive verdict. Shall the event be intermediately closed for internal managerial causes, it is necessary to open the same event again and not to report a new one.

♦ By legal costs we mean only the external ones.

Analysis by typology

Court actions where the bank is defendant (bank summoned before Court)

A) Unfavourable verdict against the bank or out of court settlement. The amount of the Gross Actual Loss will include the interests that the bank shall pay, the amount for the compensation of losses, net of the sum of original dues, and external legal expenses. Initial ET that is identified on the basis of the subject matter of the action (for example, shall a supplier initiate a legal action against the bank, the ET is 07.06)

B) Favourable verdict to the bank. The amount of the Gross Actual Loss will include only external legal expenses. Initial ET that is identified on the basis of the subject matter of the action. N.B. In case of inner legal expenses, the value of the Gross Actual Loss shall be equal to 0 and therefore the event would not be reported to DIPO.

C) Following the summons, the case might not be settled either by a favourable or an unfavourable verdict for the bank, but by an agreement and transaction between the parties with a disbursement from the bank; in this event, two sub-cases are to be taken into consideration:

♦ If the parties reach an agreement only for business purposes, without any mistake made by the bank itself, this case is not considered an operational loss

♦ When, on the other hand, the bank acknowledges an internal error, this case is considered an operational loss. The amount of the Gross Actual Loss, as in the case of legal action made against the bank, includes interests (legal/on arrears), the amounts for loss refund, net of the amount of the original dues, in addition to external legal costs.

Court actions where the bank is plaintiff

Only those actions initiated to recover the incurred operational losses.

♦ Should the bank win the case, compensation is to be recorded as other income

♦ Legal costs shall never be considered an increase of Gross Actual Loss or a curtailment of the possible collections

♦ The ET is identified on the basis of the subject-matter of the legal case (for example, shall a fraud be perpetrated by an employee, the ET is the 01.02).
The asymmetric treatment of the legal costs is justified by the fact that legal action as a plaintiff are the result of a choice by the bank in terms of mitigation strategy.

ABIServizi S.p.A.
DIPO - ITALIAN DATABASE OF OPERATIONAL LOSSES
Piazza del Gesù 49 - 00186 Roma - P.IVA 00988761003
www.dipo-operationalrisk.it - dipo@abi.it