The Advanced Measurement Approach | Next-Generation - ‘AMA-2’

The AMA-2 Framework is a RASB led practitioner/academia collaboration. It integrates accounting, operating, risk, and loss data within a common OpRisk quantification and reporting framework. It leverages the algorithms included in the Risk Accounting method and the RU, a common metric that expresses all forms of OpRisk.

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AMA 2 – The Integrated OpRisk Framework

  • Integrated Framework:
    • Accounting data
    • Operating data
    • Risk data
    • Loss history
    • Stochastic modelling
  • Two New Modules:
    • Enhanced RCSA
    • OpRisk Calculation Engine
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Overview

The integration of accounting, operating, risk, and loss data within the AMA-2 Framework is achieved through the addition of two new modules:

1. Enhanced Risk & Control Self-Assessment:

The first module is an enhanced risk & control self-assessment (RCSA) where traffic-light or ‘RAG’ assessment metrics, typically used in RCSAs, are replaced by numeric weights and risk factors. This enables the calculation of a risk mitigation index (RMI) for each business component that completes an assessment being a measure – on a scale of zero to 100 – of risk mitigation effectiveness.

2. OpRisk Calculation Engine:

The second module is an OpRisk calculation engine that produces an explicit and dynamic calculation of Inherent RUs (maximum OpRisk exposure) by product from daily new business transaction data available in accounting systems that is combined with RMIs to produce Residual RUs (actual OpRisk exposure). The engine also produces comprehensive analytics in RUs by business component, product, customer, and location including the setting and monitoring of OpRisk limits.

OpRisk is created upon the transfer of financial products and instruments to external parties as it is sales and trades that set supply chains and operating infrastructures into action. Inherent OpRisk (Inherent RUs) is calculated by combining two product related risk factors in an algorithm:

  • Exposure Uncertainty Factors (EUFs): relate to the relative operating complexity and consequent process burden each product imposes on the organisation
  • Value Band Weightings (VBWs): relate to the daily production throughput

Residual OpRisk (Residual RUs) is calculated by reducing Inherent RUs by the Risk Mitigation Index (RMI) calculated from Enhanced RCSAs.

AMA 2 Features

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OpRisk Analytics:

  • Multiple reporting categories including business component (cost centre), product, customer, and location
  • Aggregatable across the horizontal and vertical dimensions of the firm
  • Comparable within and between firms (provided the same AMA-2 Framework is applied)
  • Regularly available – at least daily
  • Actionable… feedback loops to line managers
  • Risk appetite aligned; OpRisk limit setting and monitoring in RUs
  • Derived from and traceable to official accounting records
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OpRisk Capital Calculation:

  • Stochastically modelled
  • Loss history linked to context information, i.e., exposure-to-risk in RUs and RMIs
  • Precision calculation achieved over time: loss history and exposure-to-risk in RUs statistically correlated and back-testing enabled
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The "Risk Unit" (RU) the Measure Unit for AMA 2

  • Every measurement system must have a standardized unit of measurement
  • AMA 2’s standardized unit of measurement applied to OpRisks is the Risk Unit or RU
  • The RU is an additive metric used to quantify atomic OpRisk exposures
  • The RU enables the valid aggregation of atomic OpRisk exposures to:
    • Produce cross-enterprise OpRisk analytics by group, business component, product, customer, location etc.
    • Set and monitor actual OpRisk exposures vs. operating limits
    • Analyze at the aggregate level and drill to the detail determine causal factors

  • The RU acquires intuitive understanding and acceptance over time
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The Three Core OpRisk Metrics of AMA 2

  • Inherent Risk: The amount of non-financial risk in RUs before considering the effects of internal risk mitigation activities and processes
  • Represents maximum exposure to risk
  • Risk Mitigation Index (RMI): A measure of the effectiveness of internal risk mitigating activities and processes on a scale of 0 to 100
  • Residual Risk: The amount of non-financial risk in RUs that remains after reducing inherent risk by the RMI
  • Represents actual exposure to risk

Issues with the First-Generation - Advanced Measurement Approach (AMA 1)

Single purpose… calculating capital, not managing risk:

  • No analytics or feedback loops to line management
  • Loss distribution-based… essentially backward looking

Standalone calculation:

  • Not tied to official accounting records
  • Not tied to dynamic and explicit quantifications of exposure-to-risk
  • Back-testing disenabled

Diversity of modelling approaches:

  • Vulnerability to gaming
  • Lack of bank-to-bank comparability

Inherently complex:

  • Lack of transparency

The View from the Basel Committee

2011

“…range of practice continues to be broad… diversity of modelling approaches… clearly affects the AMA methodology of individual banks and, ultimately, the amount of capital resulting from the application of the AMA”

“While flexibility allows modelling to reflect individual bank risk profiles, it also raises the possibility that banks with similar risk profiles could hold different levels of capital under the AMA if they rely on substantially different modelling approaches and assumptions”

Basel Committee on Banking Supervision

Bank for International Settlements, 2011

2017

“The inherent complexity of the AMA and the lack of comparability arising from a wide range of internal modelling practices have exacerbated variability in risk-weighted asset calculations and have eroded confidence in risk-weighted capital ratios”

“The Committee has therefore determined that the withdrawal of internal modelling approaches for operational risk regulatory capital from the Basel Framework is warranted”

Basel Committee on Banking Supervision

Bank for International Settlements, 2017

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Exploring AMA 2 and the RU – a Practitioner / Academia Research Collaboration

  • The non-financial risk quantification method used in AMA 2 was first pioneered at JPMorgan Chase (Chase Manhattan)
  • The method was deployed throughout the bank’s shared service centers / technology hubs
  • Following the financial crisis of 2007/8, work began in academia on the design of an OpRisk calculation engine that integrated risk, operating and accounting data in a common operational risk exposure quantification framework
  • A prototype calculation engine coded by researchers, based on specifications provided by the Risk Accounting Standards Board (RASB), was field-tested in collaboration with the US Federal Reserve
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AMA 2 and the RU – Published Research Papers

Peer-reviewed papers on AMA 2 and the RU published in academic journals: