Standardized Measurement Approach (SMA) vs Advanced Measurement Approaches (AMA): A Critical Review of Approaches in Operational Risk

TL;DR

This paper critically reviews the Basel Committee's proposed Standardized Measurement Approach (SMA) for operational risk, highlighting its weaknesses and advocating for the retention of the Advanced Measurement Approach (AMA) framework.

Contribution

It provides a detailed critique of SMA's limitations and argues for maintaining and standardizing the AMA internal model framework for operational risk measurement.

Findings

SMA exhibits instability and insensitivity to risk.

SMA has issues with superadditivity and systemic risk implications.

The paper supports standardizing internal operational risk models.

Abstract

The Basel Committee on Banking Supervision proposed replacing all approaches for operational risk capital, including the Advanced Measurement Approach (AMA), with a simplified formula called the Standardized Measurement Approach (SMA). This paper examines and criticizes the weaknesses and failures of SMA, such as instability, insensitivity to risk, superadditivity, and the implicit relationship between the SMA capital model and systemic risk in the banking sector. Furthermore, it discusses the issues of the proposed Operational Risk Capital (OpCar) model by the Basel Committee, a precursor to SMA. The paper concludes by advocating for the maintenance of the AMA internal model framework and suggests a series of standardization recommendations to unify internal operational risk modeling. The findings and viewpoints presented in this paper have been discussed and supported by numerous operational risk professionals and academics from various regions of the world.