The future of operational risk in financial services
In December 2017, the Basel Committee issued revised standards which include a new way of measuring the amount of Operational Risk Capital (ORC) that banks are required to hold. The traditional model-based advanced measurement approach (AMA) is being replaced by the new formula-based Standardised Measurement Approach (SMA). SMA aims to restore credibility in the calculation of risk-weighted assets (RWAS) while at the same time improve the comparability of banks’ capital ratios.
This shift in the methodology of calculating a bank’s ORC can be translated into limiting a bank’s influence over ORC to merely one variable, namely the Internal Loss Multiplier (ILM). This ILM is based on the bank’s actual 10-year operational loss history. The other two components of SMA include the Business Indicator (BI), a financial statement-based proxy for operational risk and the Business Indicator Component (BIC), calculated by multiplying the aforementioned BI by a set of regulatory-determined marginal coefficients.
The introduction of the SMA means that banks should now pay particular attention to the long-term consequences of operational losses. They will need to align these losses with business unit and executive performance, and engage in deep-rooted changes, such as proactive management of risks as well as leveraging of new automated technologies and techniques. The time has come for banks to seize upon invaluable opportunities enabled by predictive risk intelligence, big data analytics and other breakthrough innovations, so as to identify patterns and trends which will help them to proactively manage risks and reduce internal losses in the future.
Our latest publication focuses on the changes to the ORC measurement and the matters Banks will have to accommodate if they are to be compliant with the new requirements.