Should the advanced measurement approach be replaced with the standardized measurement approach for operational risk?

TL;DR

This paper critically evaluates the Basel Committee's proposed Standardised Measurement Approach (SMA) for operational risk, highlighting its weaknesses and advocating for maintaining the Advanced Measurement Approach (AMA) with standardization improvements.

Contribution

The paper provides a detailed critique of SMA's limitations and offers recommendations to improve internal modelling of operational risk, supporting the AMA framework.

Findings

SMA exhibits instability and risk insensitivity.

SMA is super-additive and linked to systemic risk.

Maintaining AMA with standardization is preferable.

Abstract

Recently, Basel Committee for Banking Supervision proposed to replace all approaches, including Advanced Measurement Approach (AMA), for operational risk capital with a simple formula referred to as the Standardised Measurement Approach (SMA). This paper discusses and studies the weaknesses and pitfalls of SMA such as instability, risk insensitivity, super-additivity and the implicit relationship between SMA capital model and systemic risk in the banking sector. We also discuss the issues with 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 internal modelling 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, UK and USA, and recently at OpRisk Europe 2016 conference in London.