LO 43.2: Describe the modeling requirements for a bank to use the Advanced Measurement Approach (AMA).
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Topic 43 Cross Reference to GARP Assigned Reading – Girling, Chapter 12
Unanticipated Results from Negative Gross Income
The BIA and TSA capital charge methodologies can produce inappropriate results when accounting for negative gross income. For example, consider the following gross income amounts multiplied by the corresponding beta factors (in $100 millions):
The advanced measurement approach (AMA) allows banks to construct their own models for calculating operational risk capital. Although the Basel Committee allows significant flexibility in the use of the AMA, there are three main requirements. A bank must: Demonstrate an ability to capture potentially severe fat-tail losses (banks must use
99.9th percentile events with a one-year time horizon). Include internal loss data, external loss data, scenario analysis, and business environment internal control factors (i.e., the four data elements).
Allocate capital in a way that incentivizes good behavior (i.e., create incentives to
improve business line operational risk management).
Under the AMA, capital requirements should be made for all seven risk categories specified by Basel II. Some firms calculate operational risk capital at the firm level and then allocate down to the business lines, while others calculate capital at the business line level. Capital
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calculations are typically performed by constructing a business line/event type matrix, where capital is allocated based on loss data for each matrix cell.
Topic 43 Cross Reference to GARP Assigned Reading – Girling, Chapter 12
Additional quantitative requirements under the AMA include: The approach must capture all expected and unexpected losses and may only exclude
expected losses under certain criteria as stated in Basel II.
The approach must provide sufficient detail to ensure that fat-tail events are captured. The bank must sum all calculated cells in the business line/event type matrix and be able
to defend any correlation assumptions made in its AMA model.
All four data elements must be included in the model, including the use of internal and
external data, scenario analysis, and business environment factors.
The bank must use appropriate weights for the four data elements when determining
operational risk capital.
While the four data elements must be considered in the capital calculations, many banks use some of these elements only to allocate capital or perform stress tests, and then adjust their models, rather than using them as direct inputs into capital calculations. Regulators have accepted many different types of AMA models, such as the loss distribution approach, given the rapid development of modeling operational risk capital.
Loss D i s t r i b u t
i o n A p p r o a c h