Risk Management and Basel II by - PowerPoint.ppt

1 riskmanagementandbaseliijavedhsiddiqiriskmanagementdivisionbankalfalahlimited 2 knowledgehastobeimproved challengedandincreasedconstantlyoritvanishes peterdruckerriskmanagementandbaseliiriskmanagementdivisionbankalfalahlimitedjavedh siddiqi 3 managingriskeffectively threecriticalchallenges globalism technology change managementchallengesforthe21stcentury 4 agenda whatisrisk typesofcapitalandroleofcapitalinfinancialinstitutioncapitalallocationandrapmexpectedandunexpectedlossminimumcapitalrequirementsandbaseliipillarsunderstandingofvalueofrisk varbaseliiapproachtooperationalriskmanagementbaseliiapproachtocreditriskmanagementcreditriskmitigation crm simpleandcomprehensiveapproach thecausesofcreditriskbestpracticesincreditriskmanagementcorrelationandcreditriskmanagement creditratingandtransitionmatrix issuesandchallengessummary 5 whatisrisk risk intraditionalterms isviewedasa negative webster sdictionary forinstance definesriskas exposingtodangerorhazard thechinesegiveamuchbetterdescriptionofrisk thefirstisthesymbolfor danger while thesecondisthesymbolfor opportunity makingriskamixofdangerandopportunity 6 riskmanagementriskmanagementispresentinallaspectsoflife itisabouttheeverydaytrade offbetweenanexpectedrewardanapotentialdanger we inthebusinessworld oftenassociateriskwithsomevariabilityinfinancialoutcomes however thenotionofriskismuchlarger itisuniversal inthesensethatitreferstohumanbehaviourinthedecisionmakingprocess riskmanagementisanattempttoidentify tomeasure tomonitorandtomanageuncertainty 7 capitalallocationandrapm theroleofthecapitalinfinancialinstitutionsandthedifferenttypeofcapital thekeyconceptsandobjectivebehindregulatorycapital themaincalculationsprinciplesinthebaseliithecurrentbaseliiaccord thedefinitionandmechanicsofeconomiccapital theuseofeconomiccapitalasamanagementtoolforriskaggregation risk adjustedperformancemeasurementandoptimaldecisionmakingthroughcapitalallocation 8 roleofcapitalinfinancialinstitution absorblargeunexpectedlossesprotectdepositorsandotherclaimholdersprovideenoughconfidencetoexternalinvestorsandratingagenciesonthefinancialheathandviabilityoftheinstitution 9 typeofcapital economiccapital ec orriskcapital anestimateofthelevelofcapitalthatafirmrequirestooperateitsbusiness regulatorycapital rc thecapitalthatabankisrequiredtoholdbyregulatorsinordertooperate bankcapital bc theactualphysicalcapitalheld 10 economiccapital economiccapitalactsasabufferthatprovidesprotectionagainstallthecredit market operationalandbusinessrisksfacedbyaninstitution ecissetataconfidencelevelthatislessthan100 e g 99 9 sinceitwouldbetoocostlytooperateatthe100 level 11 riskmeasurement expectedandunexpectedloss theexpectedloss el andunexpectedloss ul frameworkmaybeusedtomeasureeconomiccapitalexpectedloss themeanlossduetoaspecificeventorcombinationofeventsoveraspecifiedperiodunexpectedloss lossthatisnotbudgetedfor expected andisabsorbedbyanattributedamountofeconomiccapital lossessoremotethatcapitalisnotprovidedtocoverthem 500expectedloss reserves economiccapital difference2 000 0 totallossincurredatx confidencelevel determinedbyconfidencelevelassociatedwithtargetedrating probability cost 2 500 el ul 12 minimumcapitalrequirements baseliiandriskmanagement 13 history 14 comparison 15 objectives theobjectiveofthenewbaselcapitalaccord baselii is topromotesafetyandsoundnessinthefinancialsystemtocontinuetoenhancecompletiveequalitytoconstituteamorecomprehensiveapproachtoaddressingriskstorendercapitaladequacymorerisk sensitivetoprovideincentivesforbankstoenhancetheirriskmeasurementcapabilities 16 minimumcapitalrequrementsforbanks sbpcircularno6of2005 17 overviewofbaseliipillars thenewbaselaccordiscomprisedof threepillars pillari minimumcapitalrequirementsestablishesminimumstandardsformanagementofcapitalonamorerisksensitivebasis creditriskoperationalriskmarketrisk pillarii supervisoryreviewprocessincreasestheresponsibilitiesandlevelsofdiscretionforsupervisoryreviewsandcontrolscovering evaluatebank scapitaladequacystrategiescertifyinternalmodelslevelofcapitalchargeproactivemonitoringofcapitallevelsandensuringremedialaction pillariii marketdisciplinebankwillberequiredtoincreasetheirinformationdisclosure especiallyonthemeasurementofcreditandoperationalrisks expandsthecontentandimprovesthetransparencyoffinancialdisclosurestothemarket 18 developmentofarevisedcapitaladequacyframeworkcomponentsofbaselii pillar1 pillar2 pillar3 thethreepillarsofbaseliiandtheirprinciples baselii continuetopromotesafetyandsoundnessinthebankingsystemensurecapitaladequacyissensitivetothelevelofrisksbornebybanksconstituteamorecomprehensiveapproachtoaddressingriskscontinuetoenhancecompetitiveequality objectives 19 overviewofbaseliiapproaches pillari approachesthatcanbefollowedindeterminationofregulatorycapitalunderbaselii totalregulatorycapital operationalriskcapital creditriskcapital marketriskcapital basicindicatorapproach standardizedapproach advancedmeasurementapproach ama standardizedapproach internalratingsbased irb foundation advanced standardmodel internalmodel scorecard lossdistribution internalmodeling 20 operationalriskandthenewcapitalaccord operationalriskisnowtobeconsideredasafullyrecognizedriskcategoryonthesamefootingascreditandmarketrisk itisdealtwithineverypillarofaccord i e minimumcapitalrequirements supervisoryreviewanddisclosurerequirements itisalsorecognizedthatthecapitalbufferrelatedtocreditriskunderthecurrentaccordimplicitlycoversotherrisks 21 operationalriskbackground description threemethodsforcalculatingoperationalriskcapitalchargesareavailable representingacontinuumofincreasingsophisticationandrisksensitivity i thebasicindicatorapproach bia ii thestandardisedapproach tsa and iii advancedmeasurementapproaches ama biaisverystraightforwardanddoesnotrequireanychangetothebusinesstsaandamaapproachesaremuchmoresophisticated althoughthereisstilladebateintheindustryastowhethertsawillbeclosertobiaortoamaintermsofitsqualitativerequirementsamaapproachisastep changeformanybanksnotonlyintermsofhowtheycalculatecapitalcharges butalsohowtheymanageoperationalriskonaday to daybasis availableapproaches operationalriskisdefinedastheriskoflossresultingfrominadequateorfailedinternalprocesses peopleandsystemsorfromexternalevents thisdefinitionincludeslegalrisk butexcludesstrategicandreputationrisk 22 themeasurementmethodologies basicindicatorapproach capitalcharge alphaxgrossincome alphaiscurrentlyfixedas15 standardizedapproach capitalcharges betaxgrossincome grossincomeforbusinessline i 1 2 3 8 valueof greeks aresupervisoryimposed 23 themeasurementmethodologies businesslinesbetafactorscorporatefinance18 trading sales18 retailbanking12 commercialbanking15 paymentandsettlement18 agencyservices15 assetmanagement12 retailbrokerage12 24 themeasurementmethodologies undertheadvancedmeasurementapproaches theregulatorycapitalrequirementswillequaltheriskmeasuregeneratedbythebank sinternalmeasurementsystemandthiswithoutbeingtooprescriptionaboutthemethodologyused thissystemmustreasonablyestimateunexpectedlossesbasedonthecombineduseofinternallossdata scenarioanalysis bank specificbusinessenvironmentandinternalcontroleventsandsupporttheinternaleconomiccapitalallocationprocessbybusinesslines 25 understandingmarketriskitistheriskthatthevalueofonandoff balancesheetpositionsofafinancialinstitutionwillbeadverselyaffectedbymovementsinmarketratesorpricessuchasinterestrates foreignexchangerates equityprices creditspreadsand orcommoditypricesresultinginalosstoearningsandcapital 26 convergenceofeconomieseasyandfasterflowofinformationskillenhancementincreasingmarketactivity whythefocusonmarketriskmanagement leadingto increasedvolatilityneedformeasuringandmanagingmarketrisksregulatoryfocusprofitingfromrisk 27 value at riskvalue at riskisameasureofmarketrisk whichmeasuresthemaximumlossinthemarketvalueofaportfoliowithagivenconfidencevarisdenominatedinunitsofacurrencyorasapercentageofportfolioholdingsfore g asetofportfoliohavingacurrentvalueofsayrs 100 000 canbedescribedtohaveadailyvalueatriskofrs 5000 ata99 confidencelevel whichmeansthereisa1 100chanceofthelossexceedingrs 5000 consideringnogreatparadigmshiftsintheunderlyingfactors itisaprobabilityofoccurrenceandhenceisastatisticalmeasureofriskexposure 28 variance covariancematrix multipleportfolios yieldsduration incrementalvar stoploss portfoliooptimization var featuresofrmdvarmodel facilityofmultiplemethodsandportfoliosinsinglemodel returnanalysisforaidingintrade off foridentifyingandisolatingriskyandsafesecurities forpickingupsecuritieswhichgelwellintheportfolio foraidingincuttinglossesduringvolatileperiods helpsinoptimizingportfoliointhegivensetofconstraints 29 valueatrisk var valueatrisk var isaprobabilisticmethodofmeasuringthepotentionallossinportfoliovalueoveragiventimeperiodandconfidencelevel thevarmeasureusedbyregulatorsformarketriskisthelossonthetradingbookthatcanbeexpectedtooccurovera10 dayperiod1 ofthetimethevalueatriskis 1millionmeansthatthebankis99 confidentthattherewillnotbealossgreaterthan 1millionoverthenext10days 30 valueatrisk var var x zx var x thex probabilityvalueatriskzx thecriticalz value thestandarddeviationofdailyreturn sonapercentagebasisvar x dollarbasis var x decimalbasisxassetvalue 31 example percentageanddollarvar iftheassethasadailystandarddeviationofreturnsequalto1 4percentandtheassethasacurrentvalueof 5 3millioncalculatethevar 5 onbothapercentageanddollarbasis criticalz valueforavar 5 1 65 var 10 1 28 var 1 2 32var 5 1 65 1 65 014 2 31 var x dollarbasis var x decimalbasisxassetvaluevar x dollarbasis 0231x5 300 000 122 430interpretation thereisa5 probabilitythatonanygivenday thelossinvalueonthisparticularassetwillequalorexceed2 31 or 122 430 32 timeconversionsforvar var x var x 1 day jdailyvar 1dayweeklyvar 5daysmonthlyvar 20dayssemiannualvar 125daysannualvar 250days 33 convertingdailyvartoothertimebases assumethatariskmanagerhascalculatedthedailyvar 10 dollarbasisofaparticularassetstobe 12 500 var 10 5 days weekly 12 500 5 27 951var 10 20 days monthy 12 500 20 55 902var 10 125 days 12 500 125 139 754var 10 250 days 12 500 250 197 642 34 creditriskmanagement riskmanagementdivisionbankalfalah 35 creditrisk creditriskreferstotheriskthatacounterpartyorborrowermaydefaultoncontractualobligationsoragreements 36 standardizedapproach creditrisk thebanksarerequiredtouseratingfromexternalcreditratingagencies ecais longterm 37 short termratinggrademappingandriskweight 38 methodologycalculatetheriskweightedassets solicitedratingunsolicitedratingbanksmayuseunsolicitedratings ifsolicitedratingisnotavailable basedonthepolicyapprovedbythebod 39 short termrating shorttermratingmayonlybeusedforshorttermclaim shorttermissuespecificratingcannotbeusedtorisk weightanyotherclaim e g iftherearetwoshorttermclaimsonthesamecounterparty claim 1isratedass2claim 2isunrated 40 short termrating continue e g iftherearetwoshorttermclaimsonthesamecounterparty claim 1isratedass4claim 2isunrated 41 ratingsandecais ratingdisclosurebanksmustdisclosetheecaiitisusingforeachtypeofclaim banksarenotallowedto cherrypick theassessmentsprovidedbydifferentecais 42 baseliv sbaselii basel noriskdifferentiationcapitaladequacyratio regulatorycapital rwas credit market 8 regulatorycapital rwasrwas creditrisk riskweight totalcreditoutstandingamountrwas 100 100m 100m8 regulatorycapital 100mbaselii risksensitiveframeworkrwa pso riskweight totaloutstandingamount 20 10m 2mrwa abctextile 100 10m 10mtotalrwas 2m 10m 12m 43 44 creditriskmitigation crm whereatransactionissecuredbyeligiblecollateral meetstheeligibilitycriteriaandminimumrequirements banksareallowedtoreducetheirexposureunderthatparticulartransactionbytakingintoaccounttheriskmitigatingeffectofthecollateral 45 adjustmentforcollateral therearetwoapproaches simpleapproachcomprehensiveapproach 46 simpleapproach s a underthes a theriskweightofthecounterpartyisreplacedbytheriskweightofthecollateralforthepartoftheexposurecoveredbythecollateral fortheexposurenotcoveredbythecollateral theriskweightofthecounterpartyisused collateralmustberevaluedatleasteverysixmonths collateralmustbepledgedforatleastthelifeoftheexposure 47 comprehensiveapproach c a underthecomprehensiveapproach banksadjustthesizeoftheirexposureupwardtoallowforpossibleincreases andadjustthevalueofcollateraldownwardstoallowforpossibledecreasesinthevalueofthecollateral anewexposureequaltotheexcessoftheadjustedexposureovertheadjustedvalueofthecollateral counterparty sriskweightisappliedtothenewexposure 48 e g supposethatanrs80mexposuretoaparticularcounterpartyissecuredbycollateralworthrs70m thecollateralconsistsofbondsissuedbyana ratedcompany thecounterpartyhasaratingofb theriskweightforthecounterpartyis150 andtheriskweightforthecollateralis50 therisk weightedassetsapplicabletotheexposureusingthesimpleapproachistherefore 0 5x70 1 50x10 50millionrisk adjustedassets 50mcomprehensiveapproach assumethattheadjustmenttoexposuretoallowforpossiblefutureincreasesintheexposureis 10 andtheadjustmenttothecollateraltoallowforpossiblefuturedecreasesinitsvalueis 15 thenewexposureis 1 1x80 0 85x70 28 5millionariskweightof150 isappliedtothisexposure risk adjustedassets 28 5x1 5 42 75m 49 creditriskbaseliiapproachestocreditrisk standardisedapproach foundation advanced internalratingsbased irb approaches evolutionaryapproachestomeasuringcreditriskunderbaselii rwabasedonexternallyprovided probabilityofdefault pd exposureatdefault ead lossgivendefault lgd rwabasedoninternalmodelsfor probabilityofdefault pd rwabasedonexternallyprovided exposureatdefault ead lossgivendefault lgd rwabasedoninternalmodelsforprobabilityofdefault pd exposureatdefault ead lossgivendefault lgd limitedrecognitionofcreditriskmitigation supervisorytreatmentofcollateralandguarantees limitedrecognitionofcreditriskmitigation supervisorytreatmentofcollateralandguarantees internalestimationofparametersforcreditriskmitigation guarantees collateral creditderivatives baseliiprovidesa tailored or evolutionary approachtobanksthatissensitivetotheircreditriskprofiles increasingcomplexityanddatarequirement decreasingregulatorycapitalrequirement 50 creditrisk linkagestocreditprocess transactioncreditriskattributes exposureatdefault lossgivendefault probabilityofdefault exposureterm economiclossorseverityoflossintheeventofdefault likelihoodofborrowerdefaultoverthetimehorizon expectedamountofloanwhendefaultoccurs expectedtenorbasedonpre payment amortization etc creditpolicy riskrating underwriting collateral workout limitpolicy management maturityguidelines industry regionlimits borrowerlendinglimits portfoliocreditriskattributes relationshiptootherassetswithintheportfolio exposuresizerelativetotheportfolio defaultcorrelation relativeconcentration 51 thecausesofcreditrisk theunderlyingcausesofthecreditriskincludetheperformancehealthofcounterpartiesorborrowers unanticipatedchangesineconomicfundamentals changesinregulatorymeasureschangesinfiscalandmonetarypoliciesandinpoliticalconditions 52 riskmanagement riskmanagementactivitiesaretakingplacesimultaneously strategic macro microlevel rmperformedbyseniormanagementandboardofdirectors middlemanagementorunitdevotedtoriskreviews on lineriskperformedbyindividualwhoonbehalfofbanktakecalculatedriskandmanagesitattheirbest egfrontofficeorloanoriginators 53 bestpracticesincreditriskmanagement 54 increasedrelianceonobjectiveriskassessment align riskstrategy businessstrategy creditprocessdifferentiatedonthebasisofrisk notsize investmentinworkflowautomation back endprocesses activecreditportfoliomanagement 55 credit creditriskpoliciesshouldbecomprehensive setlimitsondifferentparameters creditorganisation independentsetofpeopleforcreditfunction riskfunction creditfunction clientrelations abilitytocalculateaprobabilityofdefaultbasedontheinternalscoreassigned separateinternalmodelsforeachborrowercategoryandmappingofscalestoacommonscale 56 rmdprovideswellstructured readytouse valuestatements tofairlycaptureandmirrortheratingofficer sriskassessmentundereachspecificriskfactoraspartoftheinternalratingmodel 57 creditratingsystemconsistsofallofthemethods processes controlsanddatacollectionanditsystemsthatsupporttheassessmentofcreditrisk theassignmentofinternalriskratingsandthequantificationofdefaultandlossestimates 58 onedimensional rrmd smodifiedtwodimensionalapproach ratingreflectsexpectedloss 59 creditcapital theportfolioapproachtocreditriskmanagementintegratesthekeycreditriskcomponentsofassetsonaportfoliobasis thusfacilitatingbetterunderstandingoftheportfoliocreditrisk theinsightgainedfromthiscanbeextremelybeneficialbothforproactivecreditportfoliomanagementandcredit relateddecisionmaking 1 itisbasedonarating internalratingofbanks externalratings basedmethodology 2 beingbasedonalossdistribution cvar approach iteasilyformsapartoftheintegratedriskmanagementframework 60 portfoliocreditvar 61 arecorrelationsimportant 99 99 99 67 99 35 99 03 98 71 98 39 98 07 97 75 97 43 97 11 96 79 96 47 96 15 95 83 95 51 95 19 correlation probabilityofdefault confidencelevel largeimpactofcorrelations relativecontributionofcorrelationsandprobabilityofdefaultincreditvar creditvar source s p 62 63 overallarchitecture rmd sapproach creditcapital step1fromthehistoricalcorrelationdataofindustries thefirm to firmcorrelationsarefound step2calculateassetvaluethresholdsforentiretransitionmatrix thisisdoneassumingthatgivencurrentrating theassetvalueshavetomoveup downbycertainamounts whichcanbereadoffastandardnormaldistribution forittobeupgraded downgraded step3largeno ofsimulations montecarlo oftheassetvaluethresholdspreservingthecorrelationstructureusingcholeskydecompositioniscarriedout assetvaluethresholdsareconvertedtosimulatedratingsfortheportfolioforeachofthesimulationruns step4usingtheforwardyieldcurve ratingwise andrecoverydatasuitablevaluationofeachoftheinstrumentsintheportfolioisdoneforeachsimulationrun thedistributionofportfoliovaluesissubtractedfromtheoriginalvaluetogeneratethelossdistribution 64 whatisraroc theconceptofraroc riskadjustedreturnoncapital isattheheartofintegratedriskmanagement 65 66 corporatepredictormodelisaquantitati