Beyond AMA: Putting Operational Risk Models to Good Use

Alongside credit and market risk, such operational risks were among the risk types to be capitalized under the Basel 2 framework. Under the framework, banks were allowed to use internal models to estimate operational risk capital, referred to as the Advanced Measurement Approach (AMA).

The AMA was usually calibrated to the historical losses of the bank, and was expected to provide an accurate picture of operational risk exposure. Over the last decade, AMA has become the de facto standard for measurement of operational risk across much of the financial sector and the approach was used for a myriad of purposes beyond capital calculations.

On March 4, 2016, the Basel Committee released for consultation the new Standardized Measurement Approach (SMA), which is intended to replace all previous approaches including the AMA to calculating how much capital banks must set aside to cover operational risks.

We believe the SMA consultation release presents an opportunity for banks. Since banks will need to continue to quantify operational risks, the quantification may now use approaches that best meet business needs and achieve more objectives than just capital calculations. Such approaches are likely to look very different from both the AMA and the proposed SMA.

Authors:
Ramy Farha, Principal
Tom Ivell, Partner
Thomas Jaeggi, Principal
Evan Sekeris, Partner