June 3, 2016
Comment on the Consultative Document: Standardised Measurement Approach for
operational risk, issued by the Basel Committee on Banking Supervision
Japanese Bankers Association
We, the Japanese Bankers Association (“JBA”), would like to express our gratitude forthis opportunity to comment on the second consultative document: Standardised Measurement
Approach for operational risk, issued by the Basel Committee on Banking Supervision(“BCBS”).
We respectfully expect that the following comments will contribute to your further
discussion on finalising the rules.

[General Comments]
We appreciate that the new standardised measurement approach (SMA) has greater risk
sensitivity compared to the approach proposed in the first consultative document. The
proposed framework takes into account differences in the “business model” and “complexity”
across banks, although indirectly, in addition to the bank’s “size”, by incorporating the bank’s
historical internal loss into the Loss Component. However, for the better balance between risk
sensitivity, simplicity and comparability, further revisions towards risk sensitivity arenecessary as well as consideration to reduce volatility in capital outcomes.
A due consideration is warranted for the implementation of SMA, to avoid a significant
increase in the capital requirement, as already indicated by the BCBS. The impact at anindividual bank level, as well as the industry level, should be carefully assessed. In particular,
we respectfully request the BCBS to review the multiplier for each bucket of the BusinessIndicator (BI) and that for each loss event of the Loss Component by fully factoring in thequantitative impact study (QIS) data and the results of qualitative analyses provided by theindustry.
Still, operational risk differs significantly across the business models and therefore
standardisation has its limitation. To capture such divergence, it is important to revise Pillar 1(Minimum Capital Requirements) together with Pillar 2 (Supervisory Review Process) andPillar 3 (Disclosures and Market Discipline). In particular, in order to appropriately capture
jurisdictional characteristics arising from differences in local laws and regulations, aframework for capital add-ons to individual banks under Pillar 2 should be considered, rather
than increasing the capital significantly across the board under Pillar 1.
We strongly oppose the withdrawal of the Advanced Measurement Approach (AMA)
introduced in Basel II. AMA allows banks to reflect broader potential risks with the combined1use of internal loss data, scenario analysis, forward looking information including businessenvironment and internal control factors. Incorporating risk measurement under the AMA into
regulatory capital has been an incentive for banks to enhance their internal controls and loss
prevention1. Such a framework should be retained.
Complexity and lack of comparability which are indicated as reasons for the withdrawalof the AMA can be addressed by, for example, the standardisation of models and enhanced
disclosures. In addition, certain variability in the AMA outcomes reflects differences in risk
profile across banks and hence should be accepted.
Against this backdrop, as an alternative to the AMA, we propose a hybrid approach that
identifies areas of operational risks that are amenable to modelling and those that are not, andthen measures each area accordingly. For example, low-impact and high-frequency events
such as operational errors are highly amenable to modelling, while high-impact andlow-frequency events such as huge legal cost, fines and massive earthquakes. For the latter,
we consider it reasonable to calculate capital requirement under the SMA using the BI sincethese are not amenable to modelling. However, applying the SMA to events that can bemodelled is not reasonable. Detailed discussions on the AMA are provided in Appendix.
The Specific Comments section provides our responses to each question provided in the
consultative document, and our additional requests and matters for confirmation.
[Specific Comments]<<1. Our responses to the questions>>
Question 1.
What are respondents’ views on the revised structure and definition of the BI?
(Our response)
We welcome the revised definition of BI in that improvements are made compared to thefirst consultative document; for example, the treatment of the income and expenses fromfinancial and operating lease has been revised. However, there are still some areas for
improvement.
[Treatment of internal losses for the BI]
As noted in this consultative document, the BI reflects the size of the business, while theLoss Component reflects the quality of operational risk management. However, internal losses
are not dependent on the business size, but on the quality of operational risk management.
Therefore, for the SMA, internal losses including provisions/reserves related to operationalrisk should be excluded from “Other Operating Expenses” of BI.
Provisions/reserves are used when a loss actually occurs in the future, and1

AMA is the only measurement approach that can ensure the implementation of the Principle 6 of the
Principles for the Sound Management of Operational Risk established by the BCBS.
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provisions/reserves by nature do not constitute internal losses. Also, as described in the
consultative document, the methodology for provisioning is different across banks or
jurisdictions, and therefore it is difficult to establish a uniform standard on a global basis. If
this were to be treated as an internal loss, comparability may rather decrease2. Further, inpractice, provisions/reserves are often recognised based on the conservative estimation, and in
most cases, larger than the actual losses. Consequently, treating these as an internal loss could
prevent prudent and appropriate provisioning.
If the BI were to include provisions/reserves as internal losses, the amount ofprovisions/reserves to be recognised should be limited to those that cover average losses frombusinesses. For cases that are already provisioned and result in the actual losses, bothprovisions and actual losses from the same case will be recognised in the BI, which isdouble-counting with no reasonable grounds. In view of this, losses that are alreadyprovisioned should not be included in internal loss data.
[Multiplier for the BI]
The BI reflects the size of the business and hence is not an indicator of thecomplexity of business model and the risk profile reflecting business environment andinternal control factors. Essentially, the risk sensitivity should be enhanced with the Loss
Component which reflects the complexity of business model and differences in risk profiles.
Assuming that the risk increases in tandem with the size of the business is not reasonable.
Therefore, the multiplier for each bucket of the BI should be the same irrespective of the sizeof the business.
[Methodology for the Financial Component]
Purchase or sale of securities in the banking book for long-term investment purposes are
not executed frequently and its P&L has no direct link to the operational risk. Therefore, such
P&L (Absolute Value (Net P&L on the banking book)) should not be included in the“Financial component”. On the other hand, it is reasonable to include P&L from purchase orsale of securities in the trading book in the BI.

Q2.
What are respondents’ views on the inclusion of loss data into the SMA? Are there any
modifications that the Committee should consider that would improve the methodology?
(Our response)
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Note 12: For instance, in some countries, the impact of some events (eg legal events, damage to physicalassets) may be known and clearly identifiable before these events are recognised through the establishmentof a reserve. Moreover, the way this reserve is established (eg the date of discovery) can vary across banks
or countries.
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We are of a view that the proposed revision is appropriate since the inclusion of loss data
into the SMA calculation will provide incentives for banks to enhance their operational risk
management. The internal loss data reflects the business model and risk profile such as
business environment and internal control factors. However, we propose following in order tofurther enhance the risk sensitivity.
[Scope of SMA loss data set]
The use of internal loss data allows to indirectly reflect the business model and risk
profiles such as business environment and internal control factors. However, internal losses
will be double counted for the purposes of calculating the capital adequacy ratio, because
capital will be eroded when losses occur, and at the same time internal losses will be taken
into account in the calculation of capital requirements. Thus, internal losses used for the SMA
should be limited to those that enable appropriate capturing of current or prospective risk
profile; for example, losses that are likely to occur over the future period.
If the SMA loss data set would not be limited to above-mentioned losses, internal losses
that are not likely to occur in the future should be excluded from the SMA loss data set.
Examples of such internal losses may include those that meet the following conditions: Internal losses which had occurred from a business which is not currently operating
due to, for example, changes in laws and regulations; Internal losses arising from the business that is already sold or discontinued; or Internal losses which can be ensured that such losses would not occur any more sincerisk mitigation actions have been completed.
The use of historical 10-year internal loss data for SMA purposes is not appropriate for
capturing current and future risk profile of individual bank since the business environment
surrounding each bank and the quality of operational risk management significantly changeover time. Therefore, the observation period should be reduced (for example, to 5 years). On
the other hand, the shortening of the observation period may considerably increase capitalcharge when a high-impact low-frequency loss occurs, which may give rise to a concern on
the capital stability. To address this, the multiplier for loss events above €100 million(currently set at 5) in the Loss Component should be reduced so as to avoid impairing capitalstability.
If a 10-year observation period were to be used for the internal loss data, the transitionalarrangement to temporarily allow a 5-year observation period should be permitted for
AMA/TSA banks. The definition of internal loss described in this consultative document is
not necessarily consistent with the current standards adopted by individual banks (for example,
the use of gross loss and the addition of indirect losses). Therefore, AMA/TSA banks do notnecessarily retain 10 years of the internal loss data that meet the definition set out in thisconsultative document, and hence these banks need to collect additional data. In view of this,4

when initially introducing the proposed framework, AMA/TSA banks should also be allowed
to use the 5-year period data for internal loss data under the revised standards. In addition,
G-SIBs include both AMA/TSA banks and BIA banks, and not allowing the transitionalarrangement only for AMA/TSA banks would be lack of level playing field.
[Threshold of the internal loss data used for the Loss Component]
The thresholds for the loss events in the Loss Component (€10 million and €100
million) should be raised to €100 million and €1 billion, respectively, so as to appropriately
capture huge operational risk loss events, with a view of enhancing the effectiveness of SMA
and further increasing risk sensitivity. For the same reason, the de-minimis gross loss
threshold should be raised from €10,000 to €20,000. As discussed above, if the de-minimis
gross loss threshold were to be set at €10,000, not all AMA/TSA banks have the data set thatmeets the definition under this consultative document, and hence the transitional arrangement
should also be permitted for AMA/TSA banks.
[Treatment of provisions/reserves]
Provisions/reserves related to operational risk should be excluded from operational risk
losses since provisions/reserves, essentially, are not internal losses, as discussed above. Also,
differences in local accounting standards for the recognition of provisions/reserves andpossibility of undermining sound provisioning practice should be take into account.
If provisions/reserves were to be included in the Loss Component as the internal loss
data, the scope should be limited to the provision whose related losses are set to materialise in
the following period, such as fines. And losses actually occurred should be excluded frominternal losses. Alternatively, individual banks should be permitted to establish appropriate
standards for the timing of loss recognition; i.e., whether losses should be recognised when an
actual loss has occurred, or when a provision is recognised.

Q3.
What are respondents’ views on this example of an alternative method to enhance the stabilityof the SMA methodology? Are there other alternatives that the Committee should consider?
(Our response)
We oppose the introduction of an alternative method since such a method would preventthe enhancement to risk sensitivity which is the objective set out in this consultative
document.
In order to enhance risk sensitivity, the impact of the internal loss data on the capitalrequirement needs to be further increased. However, since the alternative method is designed
in a manner to limit an increase in capital requirement for banks with huge amounts ofhistorical internal losses, such a method would be less risk sensitive and provide less5

incentives for banks to limit losses through an appropriate operational risk management. In
addition, a situation where the introduction of such method increases capital requirement forbanks with low internal loss data should be avoided.
We understand that the Internal Loss Multiplier is intended to reflect to capitalrequirements the size of historical loss experiences relative to the size of business. In thisregard, under the alternative method, both historical internal losses and the size of businessare included in the numerator and denominator, which make it difficult to understand themeaning of this multiplier.

<<2. Other requests and matters for confirmation>><Requests>[Indirect losses]
Not many banks have been collecting data on indirect losses 3 referred in thisconsultative document. Since the definition of indirect losses may differ by jurisdictions andbanks, indirect losses should be excluded from the SMA loss data set in order to ensure
simplicity and comparability.
[Timing loss]
Material “timing losses” should be limited to those that may result in material
misstatement of financial statements (for example, losses exceeding €10 million or €100
million) since, over time, there is no net impact arising from such timing losses.
[Definition of gross losses]“Gross losses net of the amount collected” should be used, since the SMA internal loss
data should reflect internal control factors such as a bank’s proactive collection efforts.
Examples of collection may include collection of erroneous remittance and a difference in theamount from remittees and collection from insurance companies, outsourcees and others
responsible for the incident. For erroneous remittance, the same treatment should be applied
to both double remittance and third-party remittance. Losses promptly collected should be
excluded from the internal loss data. Because, if erroneous inter-bank remittance ordifferences in the amount is immediately corrected, such an event is not treated as a loss inpractice, and the impact of such an event is limited.
[Implementation timing]3

6.2 (b) Costs incurred as a consequence of the event including external expenses with a direct link to theoperational risk event (eg legal expenses directly related to the event and fees paid to advisors, attorneys or
suppliers) and costs of repair or replacement, incurred to restore the position that was prevailing before theoperational risk event;6

At this stage, it is expected for banks to take considerable time in developing aframework to collect data on new accounts and internal loss data in accordance with theproposal. Therefore, with respect to implementation timing, the BCBS is requested toestablish sufficient lead time so that banks can make sure that the calculation is accurate andtimely.
[Scope of consolidation]
If a bank has a number of subsidiaries at a consolidated level, it is impracticable torequire all of its subsidiaries to satisfy the requirement to collect loss data. It is also necessary
to clarify the treatment of the BI and the Loss Component in case of the acquisition/sale of anentity or a business and discontinuity of a business. For example, it is impracticable toretrospectively collect data related to any losses occurred before the consolidation ofsubsidiaries, and use such data to calculate capital requirements. For those cases, phase-in
application and the appropriate scope of internal loss data collection based on the materiality
should be necessary.

<Matters for confirmation>[Frequency of measurement]
Please confirm that the frequency of measurement is once a year taking into account thatthe annual average is used for BI and internal loss data.
[Definition of provisions]
Please confirm that provisions included in operational risk losses refer to the amount ofprovision recognised in the P&L and not the balance of reserves on the balance sheet.
[Appendix]
Operational risk capital requirements calculated using the AMA is equivalent to the
maximum amount of operational risk losses estimated using 99 percent confidence interval
and the 10-day holding period. It takes into account the following four elements: internal andrelevant external loss data, scenario analysis, bank-specific business environment and internal
control factors.
The AMA is capable of reflecting broader potential risks to operational risk capitalrequirements because it identifies significant operational risk which banks may experience inthe future based on the combined use of these four elements, not merely internal loss data, andinput in the risk measurement model data that incorporates estimated frequency of occurrence
and loss amount. This approach would provide incentives for banks to enhance their internal
controls over potential risks, thereby strengthening the banks’ capability of operational risk
management, since, under this approach, operational risk capital requirements would increase7

as potential risks increase, even though risks may not be materialised as a loss.
Further, the AMA timely takes into account most recent changes in business environment
and internal controls, such as changes in the amount of transactions, the revisions to laws, theintroduction of IT system and the revisions to procedures. Hence, the resultant change incapital requirements fits well with management and business units.
The adequacy of capital requirement can be constantly ensured through periodic
verification of the adequacy of risk measurement model and autonomous review of the modelby banks.
AMA banks to date have evolved their operational risk management activities byleveraging the usefulness of the AMA described above. If the AMA is withdrawn, business
units of banks would take this as disapproval of their efforts to establish an operational risk
management framework that seeks to reduce risk capital charge by enhancing internal
controls. This may give rise to a concern that the control function which the risk management
department has over the business units may be weakened due to, for example, diminishing of
consciousness to prevent potential risks from being materialised; and that the stability ofbanking system may be undermined since investments to prevent the occurrence of
operational risk events will be reduced, thereby reducing the bank’s risk management
capability and resulting in massive loss events.
It is premature to discuss the withdrawal of the AMA with a short sighted view, merely
focusing on some issues with it. In order to avoid losing fruitful achievement the AMA has
gained to date, the issues of the AMA should be addressed by making necessary adjustments,
while respecting the advantages of AMA. The SMA should be viewed as a complementary
method where the AMA cannot be applied.
On the other hand, in order to enhance comparability, the variability of capital outcome
across banks caused by the AMA needs to be reduced. The AMA is a framework with a highdegree of latitude that enables to appropriately reflect differences in risk profile of individual
banks. However, it is necessary to narrow such the AMA’s latitude to some extent so as toreduce excessive variability which cannot be explained by differences in risk profile.
Specifically, following initiatives are proposed.
Convergence of risk measurement model is worth consideration; for example the use ofcommon measurement units, standardisation of methods for determining the distributions ofamounts and frequency for scenario analysis purposes, standardisation of approaches forusing external loss data. In particular, with respect to the correlation between measurement
units, the concept and treatment differ considerably across banks, and therefore, it ispreferable to introduce common guidance including the elimination of correlation.
The AMA covers broad areas of measurement, ranging from the areas where risk profile
can be captured appropriately through the internal loss data to areas where risk profile cannot
be captured through internal loss data only, such as massive natural disasters and8fines/penalties imposed by authorities.
The hybrid approach that applies the authority or industry-led standardised model to thelatter and the internal loss data based measurement to the former which can be well managedwith the incentives for banks to enhance their internal controls is a promising option thatstrikes the balance between maintaining the benefits of the AMA and increasing
comparability.
Excessive variability can be reduced by undertaking an initiative to review relative
conservativeness across AMA banks, such as an AMA benchmarking exercise conducted by
the BCBS in 2014. In addition, it is worth considering a program to introduce a measure thatserves as a benchmark for operational risk capital requirements (e.g., a better measurement
model that builds on the OpCaR established by the BCBS) and periodically review
differences against the benchmark.
The enhancement of disclosure by each bank on the nature of the risk measurement
model with the result of model validation, and the internal stress testing methodology with its
results, would serve as a significant foothold for enhancing comparability.
Various practices also exist for supervisory review and approval requirements.
Standardisation and strengthening of supervisory review and approval requirements could
enhance the comparability.
As discussed above, various issues related to the AMA could be solved. We strongly
believe that the best approach for better operational risk management is to improve theframework of the AMA.

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