How does the Standardised Measurement Approach (SMA) calculate operational risk capital, and what replaced the previous AMA framework?

The Standardised Measurement Approach (SMA) is the sole methodology for calculating operational risk capital under the finalized Basel III framework (effective January 2023 in most jurisdictions). It replaced the Basic Indicator Approach (BIA), The Standardised Approach (TSA), and the Advanced Measurement Approach (AMA) to eliminate the excessive variability that internal models produced.\n\nSMA Formula Overview:\n\nOperational Risk Capital = BIC x ILM\n\nWhere:\n- BIC (Business Indicator Component) = marginal coefficients applied to the Business Indicator (BI)\n- ILM (Internal Loss Multiplier) = adjustment based on the bank's actual loss history\n\n`mermaid\ngraph TD\n A[\"Step 1: Calculate Business Indicator (BI)\"] --> B[\"BI = ILDC + SC + FC\"]\n B --> C[\"Step 2: Apply marginal coefficients
to get BIC\"]\n C --> D{\"BI Bucket?\"}\n D -->|\"Bucket 1: BI <= EUR 1B\"| E[\"BIC = 12% x BI\"]\n D -->|\"Bucket 2: EUR 1B-30B\"| F[\"BIC = EUR 120M + 15% x (BI - 1B)\"]\n D -->|\"Bucket 3: BI > EUR 30B\"| G[\"BIC = EUR 4.47B + 18% x (BI - 30B)\"]\n C --> H[\"Step 3: Calculate Loss Component (LC)\"]\n H --> I[\"LC = 7x average annual
op risk losses (10Y)\"]\n I --> J[\"Step 4: Calculate ILM\"]\n J --> K[\"ILM = ln(exp(1) - 1 + (LC/BIC)^0.8)\"]\n K --> L[\"Step 5: OpRisk Capital = BIC x ILM\"]\n`\n\nBusiness Indicator Components:\n\n| Sub-Indicator | Formula | Captures |\n|---|---|---|\n| ILDC (Interest, Lease, Dividend) | abs(Interest income - Interest expense) + Dividend income | Balance sheet size, intermediation |\n| SC (Services Component) | max(Fee income, Fee expense) + max(Other op income, Other op expense) | Fee-based activity volume |\n| FC (Financial Component) | abs(Net P&L on trading book) + abs(Net P&L on banking book) | Market-facing risk |\n\nWorked Example -- Glenworth National Bank:\n\n3-year average financials (in EUR millions):\n- ILDC: abs(8,200 - 5,100) + 340 = 3,440\n- SC: max(2,800, 1,900) + max(650, 420) = 3,450\n- FC: abs(780) + abs(210) = 990\n- BI = 3,440 + 3,450 + 990 = EUR 7,880M\n\nBIC calculation (Bucket 2):\nBIC = 120 + 15% x (7,880 - 1,000) = 120 + 1,032 = EUR 1,152M\n\n10-year average annual operational losses: EUR 185M\nLoss Component: LC = 7 x 185 = EUR 1,295M\n\nILM = ln(exp(1) - 1 + (1,295/1,152)^0.8) = ln(1.7183 + 1.0846) = ln(2.8029) = 1.031\n\nOperational Risk Capital = 1,152 x 1.031 = EUR 1,187.7M\n\nKey Design Principles:\n- Progressive marginal coefficients ensure larger banks hold proportionally more capital\n- The ILM increases capital for banks with loss histories worse than the BIC-implied average\n- National supervisors retain discretion to set ILM = 1 for all banks (eliminating internal loss data influence)\n\nExplore operational risk capital frameworks in our FRM Part II course.