Professional Documents
Culture Documents
Management
1. Capital vs Risks
2. Regulatory Background
2/41
Banks balance sheet
Liabilities
(Debt Capital)
Assets
Equity Capital
(= Assets - Liabilities)
• Optimise return on equity capital: RoE as key indicator for investors and shareholders
• Limitations from regulator: Minimum required equity capital compared to business activities
- Solvency
- Stable financial systems, protection of local depositors
3/41
Risks of banking business
Challenge: Detect, measure and manage true risks adequately to prevent unexpected losses !!
Unexpected losses due Unexpected losses due Unexpected losses due Unexpected losses
to default of borrowers, to failures of Systems, to market movements of due to:
counterparties, processes, human or risk factors like interest a) unability to repay
emittents technical errors, external rates, stock and liabilities
events and legal currency prices b) higher refinancing
e.g. processes costs
subprime crisis e.g. c) lacking market depth
e.g. Barings Bank, new economy crash to sell assets
SocGen
4/41
Capital adequacy
Regulator: Cover risks by adequate Equity capital to ensure solvency Capital Ratio
Tier 1
• Common stakeholders
Operational Risk Equity and minority interests
• Retained earnings
• Preference shares
Risk Weighted Tier 1 • Innovative capital
Market / Assets (RWA)
Liquidity Risk covered by
adequate equity
Credit Risk
• Derivatives capital to survive‚ Tier 2
• Off balance realised‘ risks? • equity reserves / cumulative
sheet Tier 2 • preference shares
• Risk weighted
Credit Risk • Subordinated debt
balance sheet Tier 3
assets Tier 3 • Equity reserves / cumulative
• preference shares
• Subordinated debt
Capital Ratio:
Equity/RWA > 8%
5/41
Credit Risk: The new Audi S4...
Scenario 1:
Original price 50.000,- € EAD = 50.000,-
Accident frequency 1 out of 10 PD = 10%
Cost sharing 0,- € LGD = 100%
6/41
The Audi S4...
Insurance premium:
10 * 5.000,-€ = 50.000,-€
7/41
The Audi S4...
Scenario 2:
Original price 50.000,- € EAD = 50.000,-
Accident frequency 1 out of 10 PD = 10%
Retention 5.000,- € LGD = 90%
8/41
The Audi S4...
Insurance premium:
10 * 4.500,-€ = 45.000,-€
Replacement
Loss Total premium (less 5.000,-€ retention)
9/41
Credit Risk: Expected and Unexpected Losses
Loss
95 % of all cases
(19 out of 20)
Unexpected Loss
(loss volatility)
Economic Capital
Expected Loss
(average loss)
Years / Scenarios
10/41
Result
30%
11/41
Regulatory View: „BASEL committee“
„Basel II“
International
„Gentlemen‘s
Agreement“
BIZ
„SolvV“
„CRD“
European
European implementation
Capital
Requirements
Directive
12/41
Regulatory goals
is/was not adequate for • Aligning regulatory capital requirements more closely to
modern risk situation. the underlying risks
• Incentives to improve internal risk management
more forward looking
• Risk adequate pricing
if higher/lower risk than higher/lower margins
13/41
Credit Risk development: Basel I and Basel II Standardansatz
Simple rule:
Capital = RWA * 8%
14/41
Basel II: Advanced Internal Rating Based Approach (AIRB)
Simple rule:
Capital = RWA * 8%
15/41
Internal determination of default risk
General approach:
Capital Adequacy
Asset Structure and Quality
Management quality
Earnings performance
Liquidity structure of balance sheet
Sensitivity to market risk
Internal Determination of banks probability of default (PD) and loss given default (LGD):
Analysis of historical defaults and crisis in the banking sector (quantitive model)
Qualitative Analysis by relationship manager and credit risk analysts to adjust quantitative model
16/41
Credit Risk Portfolio Model
Issues:
Basel III
17/41
Basel II framework
BASEL II
ICAAP1 SREP2
Regulatory Capital
Economic Minimum requirements
Capital for Risk Management
(MaRisk = national implementation)
1 Internal Capital Adequacy Assessment Process
2 Supervisory Review and Evaluation Process
Last year AIRB-Ansatz and AMA-Ansatz
sucessfully approved by german regulator
18/41
Operational Risk
Operational risk has always been there and lies at the heart of a lot of high losses and
even bankrupticies Barings Bank, SocGen…
Benefits from optimising processes, efficient controls and transparent loss and risk
analyses are not just prevention of catastrophic losses but also leads to lower costs in
the normal business running
19/41
Methods to calculate OpRisk capital charges
20/41
OpRisk Controlling Framework: AMA
Bonus-Malus-Value System
21/41
Economic Capital
Should reflect ‚true‘ risk profile of bank Consideration of all quantifiable risks
Economic Capital
Market and
Credit Risk Operational Risk Business Risk
Liquidity Risk
Market
Operational events volatility Earnings
Defaults volatility
22/41
Pillar 2: Minimum requirements on risk management
3. Risk strategy
23/41
Overall responsibility of Common understanding of risk strategy
1. Board of Directors and organisation / processes
Riskstrategy
Risk-
quantification CRO
Risk-
transparency Risk Credit
committee committee
Risktypes
Credit Risk Market Risk Liquidity Risk
Operational Risk (Legal Risk) Business Risk
Market Risk
25/41
• Implementation of risk strategy
3. Risk strategy • Close relation to business strategy
• Inclusion of qualitative risk types
Buffer
Concentration
Branches
Limits for
Countries Expected Loss
and Risk
Segements Concentration
Products
26/41
4. Integration into bank management
Group
Risk taking capability analyses:
Ecap = Σ Risks < disponible Equity
Business Lines
Risk-adjusted performance analyses :
RoRaC = Profit / Ecap
Capital allocation
Client/product
Pricing and Product design
Ensures profitability of bank
27/41
Management Reporting FI Portfolio
Comparison RoRaC and RoE
RoRaC=
Profit / ECap
RoE=
Profit / RegCap
RORAC (%)
Economic Capital
Reg
Credit Market Op Business ECAP Capital RO ROE
Economic Capital Risk Risk Risk Risk ECAP (Avg) (Avg) RAC (Avg) Profit
ZFI 100 0 35 5 140 135 280 25% 15% 70
28/41
Sales Steering Concept
Pricing
Implementation of Ex-Ante pricing tool at point of sales
• Results of Transaction: Value Contribution Margin
• Transaction Indicators: RoRaC, eCap, Basel II Capital, Risk Concentration
Reporting
Implementation of Ex-Post Client Profiles
• Key Performance Indicators: Portfolio Quality Index, RoRaC, Ø-PD, CB-Rating, ØCVaR in T€
• Breakdown by Product Category and Client: Revenues, EL, eCap-Costs, OpRisk-Costs, Direct Costs,
VCM
Steering
• Consideration of risk/return key indicators in individual target objectives and renumeration scheme
29/41
Value orientated credit pricing concept
Example:
Price
(Gross Margin) Expected Loss = 1,5% * 50%
PD
LGD
Capital
el II: omic
Bas / Econ Unexpected Loss = 16% * (1,8%+0,9%)
Basel I AIRB
Price Minimum required
Return on Capital:
of Risk
Unexpected Credit Risk:
Expectes Loss + Capital Costs
Unexpected OpRisk:
Admin / operating costs
Admin costs: 0,3 %
Refinancing costs
31/41
Portfolio- and Scenario Analyses (in all risk dimensions)
Scenario
Analyses
e.g.
Impact of
Hedging,
True sales,
Syndication,
New business
Portfolio
Analyses
32/41
Ex-Post Client Profile
Client Profile
GBKdNr -- Country --
SWIFT Code -- Sales Unit 4 Revenues 2007 - Breakdown by Product Category (in T€)
VBKdNr -- Segment --
100.000,0
Group --
80.000,0
60.000,0
2006 2007 Δ in %
Revenues 0,0 T€ 0,0 T€ + 0,0% 40.000,0
- Expected Loss (EL) 0,0 T€ 0,0 T€ + 0,0%
20.000,0
- eCap Costs 0,0 T€ 0,0 T€ + 0,0%
- Direct Costs 0,0 T€ 0,0 T€ + 0,0% 0,0
VCM 0,0 T€ 0,0 T€ + 0,0% Total Cash Trade Banking Market Others
Revenues Services Services Products Products
50.000,0
33/41
Pillar 3: Market Discipline
Bank
Market
Discipline:
Indirect pressure
Disclosure
to improve Risk
Management and
capital adequacy
Market
34/41
Pillar 3 : Issues
Frequency?
Disclosure = Transparency ?
Disclosure of proprietary informations ?
Benefit from Pillar 3 ?
35/41
Pillar 3 : Disclosure examples (32 altogether)
36/41
Overall Picture
Equity Capital
37/41
Capital Market Informations
Information
• Credit Risk
• Liqui Risk
• Recovery
but
high volatility
Bond
Spreads
Should be
equal but they
are not quite
often
38/41
Capital Market Informations
39/41
Capital Market Informations
40/41
Thank you for your attention!
Contact Dr. Oliver Kaufmann
Tel.: ++49 (0)69 / 136 22244
E-Mail: oliver.kaufmann@commerzbank.com