ABSTRACT

This paper explores the reasons for the pending demise of the advanced measurement approach (AMA) to operational risk, which was introduced through Basel II in 2004. The author identifies a number of drivers of the Basel Committee on Banking Supervision (BCBS) decision, and argues that, although the drivers of the BCBS decision to withdraw the AMA include failings on the part of banks, there have also been significant regulatory failures that have undermined the AMA. The author then considers the new standard measurement approach (SMA), which will replace the AMA (as well as the basic indicator approach (BIA) and the standardized approach (TSA)), and identifies potential benefits from the introduction of the SMA to those firms currently using the BIA or TSA. In relation to firms using the AMA, the author contends that there is a possibility that the SMA will unleash a new era of sophisticated analytics through Pillar 2; however, this will depend on the recalibration of the SMA as well as the proper use of Pillar 2 by supervisors. Nevertheless, the author concludes that if the calibration is not addressed, and if Pillar 2 is not applied correctly, the result will be a perfect storm scenario. This may present significant systemic risk, as large global systemically important financial institutions are incentivized to take more risk on the one hand and invest less in risk management on the other.