UCL Research Shows that SMA Reforms Introduces Capital Instability and Discourages Risk Management

Ariane Chapelle, Gareth W Peters, Pavel V Shevchenko and Bertrand Hassani

As members of the University College London Faculty and risk specialist, we felt that it was our duty to produce an official response to the Basel Committee’s consultation of the proposed reform of operational risk capital calculation into a “Standardized Measurement Approach” (SMA). This response was published in September 2016 by the Journal of Operational Risk under the title “Should the Advanced Measurement Approach be replaced by the Standardized Measurement Approach for operational risk?” and has been awarded “Paper of the Year” by Risk in 2017. This chapter is a short version of our position. We demonstrate that SMA fails to achieve the claimed objective of robust capital estimation, risk sensitivity, and prudential objective for the financial industry.

SMA INTRODUCES CAPITAL INSTABILITY

The formula proposed by the Committee as the future regulation for the capitalization of operational has significant weaknesses. One of them is significant capital instability. Our analysis shows that, a given institution can experience the situation in which its capital can more than double from one year to the next, without any changes to the parameters, the model or the BI structure

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