SMA approach for Operational risk

[FrmL2_Aspirant]

Hi @David Harper CFA FRM

Wrt calculation of business indicator -> ILDC + SC + FC, the complete formula for SC is extremely lengthly. In your opinion do we need to remember it, is it testable ?

 

[David Harper CFA FRM]

Hi @FrmL2_Aspirant Good question. As the SMA for OpRisk is new to 2017 (i.e., P2.T7.R56 is a new addition), I can't really know the answer. In recent years, I think GARP has been pretty responsive to feedback requesting that they be deliberate with respect to the Learning Objective verbs, where specifically nobody wants to see the "calculate" and "compute" employed in sections where candidates do not really need to have formulas memorized (because such guidance can be a real time-waster, has been our position). In recent years, many of the readings have been "softened" this way (i.e., removing "calculate" verbs where formulas cannot realistically be expected) so that study time isn't wasted. So the readings that are seasoned are better about that; i.e., where candidates don't need to have formulas memorized, GARP has been pretty good about keeping it conceptual or qualitative. But the reality is that a brand new reading can be imprecise in the first iteration.

Given that background, I was surprised to see the "calculate" verb in these LOs (emphasis mine):

• Explain the elements of the proposed Standardized Measurement Approach (SMA), including the business indicator, internal loss multiplier and loss component, and calculate the operational risk capital requirement for a bank using the SMA [um, seriously? have they seen the full BI? this must mean just the high-level addition ...]
• Compare the SMA to earlier methods of calculating operational risk capital, including the Alternative Measurement Approaches (AMA), and explain the rationale for the proposal to replace them.
• Describe general and specific criteria recommended by the Basel Committee for the identification, collection, and treatment of operational loss data.

... however, if you are asking for my opinion, then given (i) how this SMA is controversial and, as i understand may even be in long-term doubt, and (ii) the highly tedious (ridiculously tedious, is it okay if i write that?) nature of the specific SMA, I don't see how it is possible to expect candidates to calculate the BI from scratch. So, personally I think trying to memorize it would be .. hmm, how to put this ... sort of a terrible use of time. Or put another way, I am not sure how that "calculate" clause will survive unless the question merely asks you to sum the three components! I think you will be fine to focus on the concept and the high-level definition which you have already stated: BI = ILDC(avg) + SC(avg) + FC(avg) with an understanding of these components. I hope that's helpful!

 

[FrmL2_Aspirant]

Hi @FrmL2_Aspirant Good question. As the SMA for OpRisk is new to 2017 (i.e., P2.T7.R56 is a new addition), I can't really know the answer. In recent years, I think GARP has been pretty responsive to feedback requesting that they be deliberate with respect to the Learning Objective verbs, where specifically nobody wants to see the "calculate" and "compute" employed in sections where candidates do not really need to have formulas memorized (because such guidance can be a real time-waster, has been our position). In recent years, many of the readings have been "softened" this way (i.e., removing "calculate" verbs where formulas cannot realistically be expected) so that study time isn't wasted. So the readings that are seasoned are better about that; i.e., where candidates don't need to have formulas memorized, GARP has been pretty good about keeping it conceptual or qualitative. But the reality is that a brand new reading can be imprecise in the first iteration.

Given that background, I was surprised to see the "calculate" verb in these LOs (emphasis mine):


... however, if you are asking for my opinion, then given (i) how this SMA is controversial and, as i understand may even be in long-term doubt, and (ii) the highly tedious (ridiculously tedious, is it okay if i write that?) nature of the specific SMA, I don't see how it is possible to expect candidates to calculate the BI from scratch. So, personally I think trying to memorize it would be .. hmm, how to put this ... sort of a terrible use of time. Or put another way, I am not sure how that "calculate" clause will survive unless the question merely asks you to sum the three components! I think you will be fine to focus on the concept and the high-level definition which you have already stated: BI = ILDC(avg) + SC(avg) + FC(avg) with an understanding of these components. I hope that's helpful!

thank you very much David, I thought I was the only one thinking it is ridiculous for GARP to expect one can memorize the complete formula..

 

[sharman.jamie]

Looking at question 10 for the 2018 sample paper it looks like we are expected to memorise the BI buckets!!! Unbelievable!

 

[David Harper CFA FRM]

@sharman.jamie Good point, I will to include this question in my feedback memo to GARP, that I am currently writing (i.e., the utility of such memorization eludes me, especially given that Basel is always changing its mind!)

 

[sharman.jamie]

Thanks, wow it's a seriously tough exam. Really feeling the jump from Part I to Part II.