Alert June 14, 2011

Federal Banking Agencies Issue Guidance on Advanced Measurement Approaches for Operational Risk

On June 3, 2011, the OCC, FRB, FDIC and OTS issued interagency guidance (the “Guidance”) on Basel II’s advanced measurement approaches (“AMA”) for calculating risk-based capital requirements for operational risk for large, internationally active banking organizations (as implemented in the U.S.).  The Guidance discusses certain common implementation issues, challenges and key considerations for addressing such challenges in implementing a satisfactory AMA framework, with a focus on the combination and use of the four required AMA data elements: (i) internal operational loss event data; (ii) external operational loss event data; (iii) business environment and internal control factors; and (iv) scenario analysis.

With respect to internal operational loss event data, the Guidance provides that banks should use at least five years of data, have documented support for their internal data collection threshold(s), and include legal losses in its quantification processes using a date no later than the date a legal reserve is established.  The Guidance also states that banks should have credible, transparent, systematic and verifiable processes for sourcing, selecting, scaling and modeling external data.  Banks should also have sound practices to ensure a systematic assessment of risk across its organization and have a scenario analysis process that is clearly defined, repeatable and transparent (to ensure the integrity of the process).

The Guidance specifically notes that it is not intended to address the treatment of operational risk in a bank’s internal capital adequacy assessment process.