Don’t Let the SMA Kill OpRisk Modelling

Ariane Chapelle and Evan Sekeris

A messy compromise that pleased no-one, one doesn’t have to look far for critics of the Basel Committee’s proposed standardised measurement approach (SMA) to calculating operational risk capital requirements.

Peter Sands, the former chief executive of Standard Chartered, recently claimed here that the SMA, as proposed, provides few – if any – incentives for banks to improve their management of operational risks.

The industry’s frustration with the operational risk capital framework is clear – and justified, given patchy implementation of the current advanced measurement approach (AMA), and the ill-conceived attempt to address that problem with the SMA. We agree with Sands’ characterisation of the proposed SMA as being too simplistic, exclusively backward looking and conceptually flawed. We documented our concerns when the first SMA draft was released by the Basel Committee; at the OpRisk North America conference; and in the Journal of Operational Risk.

But the current debate has become mired in confusion between the concept of capital for operational risk and the execution of that concept through the AMA. The fact that existing efforts have failed should not be misconstrued