Chase Cooper

AMA: perception says valueless, reality says invaluable...

The advanced measurement approach is proven to add significant benefits, says John Kiddy, CEO, Chase Cooper, so why is it so underused?

The advanced measurement approach (AMA) survey highlights a significant gap between financial institutions' expectations and the actual AMA implementation experience.

Forty-one percent of respondents are not planning to implement an AMA programme. The overriding reason for 55% of these respondents is a belief that there are either no business benefits or an insufficient capital charge reduction. Even more startling is the statistic that among the firms planning an AMA programme, 48% believe there is only 'some benefit' to be derived from the programme as opposed to 'significant benefit'.

All of this is in marked contrast to the experience of firms currently using AMA modelling, where according to the survey all firms derive business benefit, with 67% rating the benefit as 'significant'. What is also apparent from the experiences of firms that have an AMA programme is the business impacts obtained that are quite separate from, and supplemental to, any potential reduction in capital charge.

These benefits leading to improved business decision-making and efficiency have included:

• More comprehensive event capture, including near misses

• More effective and focused 'event analysis'

• Greater clarity in defining and using risk appetite

• Greater focus and analysis of external losses

• Higher standards for the RCSA process

The AMA process is thus a catalyst for extra focus on components of op risk management that result in better risk management and significant impact on risk profiles and loss reduction. In addition, the AMA programme can greatly facilitate the development and usage of economic capital models, with the effect of, for example, creating incentives for business units to comply with OR policies, by deriving a risk-adjusted return on capital and capital allocation.

In our view many of the business benefits to be derived from an AMA programme are not readily apparent before the implementation of the programme. In fact, there are deep benefits to be gained through process improvement and a better understanding of the firm's op risk profile - all of which flow to the bottom line, irrespective of any AMA capital benefit.

Firms that have derived significant benefits have done so in many cases, paradoxically, because of the need to supplement internal loss data. They have been forced to gather and carefully analyse external loss data, for example analysing whether the events described are applicable to their firms, and if so what measures and controls can be taken to mitigate the risk of these events happening. Can it be seriously argued that this process has no value? Wouldn't shareholders and investors expect this to be done?

Those implementing AMA have also been forced to supplement loss data by scenario analysis and RCSA data. In our view the quantitative analysis of RCSA data is something the industry as a whole will embrace much more, but the fundamental point is that an AMA programme forces the issue as a necessity.

Further interesting results have emerged from the FSA's Operational Risk Management Practices - Feedback from the thematic review published in October 2007. For example:

• 90% did not make the reading of its OR policy compulsory

• 75% did not have an economic capital model

• 73% did not apply stress testing to OR

• 66% did not undertake scenario analysis

• 50% of firms surveyed do not subscribe to an external loss data base.

• 50% did not use groups of people to identify risks

• 50% did not have risk committees to provide challenge to risk assessments

• 33% did not have a mechanism to verify accuracy of past risk assessments

• 33% did not report near misses

• 'Several' firms were 'struggling' with the sheer volume of RCSA data

There are a number of other surprising findings, but the point is that, in our opinion, most of the above are vital components to an effective OR programme - regardless of whether a firm makes an AMA application.

However, we constantly see that the successful implementation of an AMA programme forces and incentivises almost all these best practises to happen. So why are these components of effective op risk not embedded as standard practice throughout the industry?

Is it because the business benefits of good ORM have not yet been fully recognised by the industry? Effective op risk management is fundamental to the protection and sustainability of our financial system, as well as being vitally important to the protection of investors, market participants and shareholders.

The FSA adopts a 'No compulsion/No prohibition' regime for the choice of capital charge calculation. Could this perhaps be the root of the issue?

The 'No compulsion/No prohibition' principle was introduced at the Madrid Summit many years ago to deal with the transition to the introduction of the euro.

Is it really appropriate to apply this principle to methods of capital calculation? In my view the answer to this is probably yes, but the real issue is should the choice of capital charge calculation determine the standards of OR practices? The answer to that should be a resounding no.

Chase Cooper is a risk and compliance management solutions provider. Its award-winning software solution aCCelerate includes market-leading RCSA software incorporating full integrated modelling, supporting capital calculation and control efficiency modelling. Chase Cooper also has an award-winning consultancy team specialising in ORM, helping firms realise the business benefits of ORM and among many other services, carries out AMA model reviews, and assists in preparing waiver applications. For more information contact Rohini Upal on [phone], or visit www.chasecooper.com

For more information visit www.chasecooper.com or contact Rohini Uppal on 0207 017 3080