Standardized measurement approach: is comparability attainable?

Abstract

Recently, the Basel Committee on Banking Supervision (BCBS) published a consultation paper that proposed a radical change to the methodologies permitted for estimating operational risk regulatory capital (ORRC). The Committee proposed replacing all existing approaches with a single new formula, the standardized measurement approach (SMA), which, it is claimed, will be simpler and promote comparability of estimated ORRC across banks. This proposal has, however, been widely criticized by practitioners and academics on both theoretical and practical grounds. Recent studies have demonstrated that, far from promoting comparability, the proposals have the potential to increase rather than reduce variability in the estimation of ORRC across banks. This paper adds to this critique by considering the practical issues of the consistency of operational loss data that are necessary for comparability to be observable. The paper concludes that comparability is not attainable as desired by the SMA proposal, not least because the collection of operational loss data will remain determined by individual bank rules and will not be based on agreed common standards. The paper discusses arguments made by academics and practitioners against the proposal and, finally, makes a suggestion to the BCBS that a comprehensive fundamental review, similar to that recently completed for market risk, should be undertaken for operational risk.