susan schmidt bies : observations on measuring and managing operational risk under basel ii remarks by ms susan schmidt bies, member of the board of governors of the us federal reserve system, at the federal reserve systema€™s conference on implementing an advanced measurement approach for operational risk, boston, 19 may 2005. * * * good morning and welcome to the federal reserve's conference - " implementing an advanced measurement approach for operational risk. " it gives me great pleasure to open this conference. i would like to thank the federal reserve bank of boston and board staff for organizing this important event and all the speakers for the time and effort they have devoted to making this conference worthwhile. indeed, judging from the impressive lineup of speakers, this conference should be a highly useful forum for an exchange of ideas. i also want to extend a special welcome to the international supervisors and bankers who are in attendance. i know that some of you have spent the earlier part of this week sharing your views about and experiences with the implementation of the basel ii operational risk framework and working to achieve an appropriate level of consistency in implementation across countries. our hope is that this conference will broaden and deepen the understanding within the banking and regulatory community of operational - risk measurement techniques, both quantitative and qualitative, particularly as they relate to the development of the advanced measurement approaches, or amas. i think you have an interesting two days ahead of you, with an opportunity to hear the current state of implementation from banks and regulators. specifically, this morning you will hear supervisors describe the range of practices they observed during the " interagency ama benchmarking exercise " conducted last year at institutions that will likely be required to adopt basel ii. they will also summarize the results of the operational - risk - loss data - collection exercise and fourth quantitative impact study - known as qis4. this afternoon you will hear from academics and practitioners who are experts in measuring operational risk, and tomorrow you will hear from financial institutions who will share their practical experiences in designing and implementing operational - risk measurement systems and then from regulators on the outstanding policy issues. today, i would like to address some of the practical aspects of implementing basel ii in the united states, including some observations on progress being made in the management and measurement of operational risk as well as some observations on the challenges associated with implementing an ama. implementation of basel ii in the united states the agencies'reaction to the results of qis4 shows how seriously we are taking basel

unit management processes. in other words, the business - line staff should be in the process of developing the firm - wide operational - risk measurement framework. while firms generally are developing corporate - level operational - risk management functions and firm - wide policies and procedures to bring greater consistency to how operational risk is measured throughout the institution, business - line staff can add significant value to this effort through their understanding of inherent risks and controls in their areas. and finally, the more business - line staff is involved in the development of the measurement framework and the more transparent the framework is, the more credible will be the process of allocating the total capital number back to the business lines - an effort in which many of the banks represented here today are now engaged. to be meaningful, the quantification of operational risk must be forward - looking. this means that a mechanical focus on historic loss data series will not work. we must recognize the roles of qualitative factors and a well - reasoned assessment of what we will call stress events or scenario analysis. in this regard, the burden is on management to exercise judgment. clearly, this judgment must include consideration not only of a soundness standard but also of contingencies and actions taken to reduce the risks posed by those contingencies. a self - assessment of the internal control structure and overall risk - management process is crucial. clearly, this is not a simple process if the results are to be relevant to the specific risk profile of the firm. but based on the progress we have seen to date in this area, i think you are up to the challenge and i encourage you to keep moving forward. before i wrap up, i would like to say a few words directly to the potential " opt - in " institutions. an institution that does not meet the mandatory criteria in the framework will be under no obligation to adopt basel ii. some potential opt - in institutions have complex and varied operations and are developing enhanced enterprise - wide risk - management processes and systems to strengthen their internal control environments. these institutions understand that complex operations receive a more structured and well - defined risk - management framework to monitor the effectiveness of internal control processes and risk exposures. for these organizations, the incremental cost to opt into basel ii advanced approaches will be a relatively moderate incremental cost. for other financial institutions, with a simpler organizational structure and less - complex processes and services, a less - sophisticated enterprise - wide risk - management and - measurement is entirely appropriate. for these organizations,