Operational Risk Modelling is Dead, Long Live Operational Risk Modelling!

Evan Sekeris and Ramy Farha

On March 4, 2016, the Basel Committee on Bank Supervision (BCBS) released a draft proposal of the new capital framework for operational risk, the standardised measurement approach (SMA). The SMA will replace all existing alternatives for capital calculation: the basic indicator approach (BIA), which applies a single 15% multiplier to the average annual gross income of a bank, the standardised approach (SA), which applies different multipliers to income across a set of standardised business lines, the advanced standardised approach (ASA), which applies the multiplier to loans, advances and volume business rather than gross income for two out of the eight units of measure, and the advanced measurement approach (AMA), under which capital is determined by internal models. All simple approaches were calibrated in the early 2000s when very little loss data was available and operational risk was still not well understood. The calibrations are as much guesswork as the result of any type of analysis. Consequently, the resulting capital requirements were more akin to guesstimates that often underestimated capital, as evidenced by the dramatic increase in capital requirements in the wake of