Comments on the BCBS proposal for a New Standardized Approach for Operational Risk

TL;DR

This paper critically examines the Basel Committee's new Standardized Measurement Approach for operational risk, highlighting its shortcomings in risk sensitivity, differentiation, and its disconnect from management actions, raising concerns about its effectiveness.

Contribution

The paper provides an in-depth analysis of the SMA's behavior under various conditions, revealing significant limitations and potential drawbacks compared to previous standards.

Findings

SMA does not respond well to changes in risk profiles.

SMA results are more variable across banks than previous methods.

SMA may lead to over- or under-insurance against operational risks.

Abstract

On March 4th 2016 the Basel Committee on Banking Supervision published a consultative document where a new methodology, called the Standardized Measurement Approach (SMA), is introduced for computing Operational Risk regulatory capital for banks. In this note, the behavior of the SMA is studied under a variety of hypothetical and realistic conditions, showing that the simplicity of the new approach is very costly on other aspects: we find that the SMA does not respond appropriately to changes in the risk profile of a bank, nor is it capable of differentiating among the range of possible risk profiles across banks; that SMA capital results generally appear to be more variable across banks than the previous AMA option of fitting the loss data; that the SMA can result in banks over- or under-insuring against operational risks relative to previous AMA standards. Finally, we argue that the SMA is not only retrograde in terms of its capability to measure risk, but perhaps more importantly, it fails to create any link between management actions and capital requirement.