Should the Advanced Measurement Approach Be Replaced with the Standardized Measurement Approach for Operational Risk?

Abstract

Recently, the Basel Committee for Banking Supervision proposed to replace all approaches, including the advanced measurement approach (AMA), to operational risk capital with a simple formula referred to as the standardized measurement approach (SMA). This paper discusses and studies the weaknesses and pitfalls of the SMA, such as instability, risk insensitivity, super-additivity and the implicit relationship between the SMA capital model and systemic risk in the banking sector. We also discuss issues with the closely related operational risk capital-at-risk (OpCar) Basel Committee-proposed model, which is the precursor to the SMA. In conclusion, we advocate to maintain the AMA internal model framework and suggest as an alternative a number of standardization recommendations that could be considered to unify the internal modeling of operational risk. The findings and views presented in this paper have been discussed with and supported by many OpRisk practitioners and academics in Australia, Europe, the United Kingdom and the United States, and recently at the OpRisk Europe 2016 conference in London.

Keywords: operational risk (OpRisk), standardized measurement approach (SMA), loss distribution approach (LDA), advanced measurement approach (AMA), Basel Committee for Banking Supervision (BCBS) regulations