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FRM Part II · FRM Exam Part II · Introduction to Operational Risk and Resilience

A risk manager notes that the SMA ILM uses a bank's ten-year average annual operational losses above a threshold. Which statement best describes a key rationale for including internal loss history in the SMA?

Internal loss history adds risk sensitivity to the SMA. Banks with weaker control environments and higher historical losses face higher capital, while those with lower losses may benefit, while the BIC still anchors the calculation and no internal models are used.

  1. AIt makes capital sensitive to a bank's own loss experience, rewarding stronger control environmentsCorrect
  2. BIt removes all dependence on the Business Indicator
  3. CIt allows banks to use their own severity distributions
  4. DIt guarantees capital will equal the 99.9% VaR of losses

Explanation

The ILM scales the BIC by the bank's own historical losses, so banks with persistently low losses may get lower capital and those with high losses higher. The BI remains the base. The SMA does not permit internal distributions or target a VaR level.

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