Advanced Bank Risk Management

Course Overview Many banks are now compliant with Basel II. What next? As the result of the Western banking crisis, there are many changes proposed to the Accord, commonly known as Basel II.5 and III. What will be the impact of these changes on the capital requirements and, more broadly, on the future business strategy of the bank? Did Risk Management have a good crisis? Many institutions are re-organising and empowering risk management as a result of the crisis. Enterprise-wide risk management has been a phrase talked about for at least twenty years; banks are started to take the basic concepts much more seriously – why? How does risk management evolve beyond the Accord? The objectives of this 4 day programme are: To address these broader issues; To discuss implementation of the more advanced methods currently permitted in the Accord; To discuss some of the changes that have been proposed to the Accord since the Western banking crisis of 2007-9; To raise other developments in risk management that are taking place. In more detail, the course will address the following topics: Why Risk Management has become so crucial to Financial Institutions What decisions you need to make when implementing the new Accord, and what is the timelines How should Risk Management be organised Estimate the level of Economic Capital required to underpin any transaction, and therefore address the question: how much Economic Capital does an institution require? Analyse the major forms of risk generated by financial institutions, particularly within a Value-at-Risk framework What are the competing internal approaches to the measurement of Credit Risk How to implement an Operational Risk methodology successfully What methodologies for Operational Risk measurement are becoming industry-standard Does modelling work: how to mitigate the really big events that may bring you down! It will be assumed that all participants will be familiar with the broad framework of the Basel Accord. To reinforce the course, there are: A wide range of real-life case-studies discussing the lessons we should learn from these failed institutions - could the same events happen at your institute? Details and computer simulations of the latest techniques to model market, credit and operational risk, and discussions about commercially-available software; delegates will get the opportunity to interact with the simulations.
Day 1 Bank Risk Management Introduction What triggered the Western banking crisis? Where were risk management – were they asleep? Lessons that must be learnt: culture, organisational structure, expertise, data EWRM: what is it? Why is it important at this juncture? Development of an EWRM environment What do we expect to see addressed in such an environment? - Organisational structure - Roles and responsibilities of the senior management - Corporate governance and the creation of a risk culture - Empowerment of risk management - Statement of risk appetite - Risk reporting and the understanding of risk - Roles and responsibilities of the Business Lines - Who should be managing risks? - Integration of risk within reporting lines - Roles and responsibilities of the Risk Group - Developing more robust risk assessment - Reduction of model risks - Creation of risk management policies and procedures The COSO framework – how applicable to banks? Raising the quality and transparency of the capital base Going concern and gone concern Revisions to the capital definitions: Equity and Additional Tier 1 Regulatory adjustments Revisions to the capital mix Building of a capital buffer to reduce procyclicality Building of a capital buffer to reduce excess credit growth Systemically important banks Days 2 & 3 Risk Analytics How are these assessed – quantitatively or qualitatively? What are the usual methodologies? Development of an ICAAP – a brief overview - What is an ICAAP? - What should it contain? - Background information - Identification of all relevant and material risks - Guidance provided by supervisors - Additional re-focussing of the ICAAP under Basel III Methods for assessing credit risk have fundamentally changed over the past fifteen years. Why, and what are the new approaches? The effectiveness of the traditional process: what works and what does not? - Level 1 Credit Risk Management What are the fundamental concepts of the new approach? Basic data requirements: Exposure at Default, Probabilities of Defaults, Loss Given Defaults and correlations - How to estimate EADs and EPEs - How to estimate PDs: Each approach will be briefly and yet critically discussed - Through-the-Cycle vs. Point-in-Time PDs - Use of historic data, supplemented by using data from external parties - Various models to supplement the estimation - Statistical factor models such as scorecarding and logistic regression - Modifying PDs for the economic cycle - Using Vasicek’s model to adjust for the economic cycle - Traditional qualitative credit rating systems - How to estimate LGDs - Distressed cashflow modelling - Factor modelling - PD modelling - Modelling a credit portfolio - Why is this important – concentration risk - A brief outline of portfolio credit modelling - Analytically modelling portfolio default assuming independence - Simulating portfolio default - Introducing correlations - Estimation of correlations - Construction of a loss distribution and the calculation of credit VaR - Modelling a realistic portfolio using simulation - Modelling a realistic portfolio using a semi-analytic approach - Measuring concentration risk - How does this arise? - What is the impact on the Loss Distribution and the VaR - Implementing such a model in practice - Extension of the default model to a migration model – as required by IRC - Modifications for financial institutional counterparties Introduction of a Leverage constraint - Why this has been thought to be necessary? - What is the practice in US and Switzerland? - Precise details of the proposed constraint - What is its likely impact? Market risk is often divided into two categories: traded and non-traded (often called Interest Rate Risk in the Banking Book). Traditionally, banks have applied different approaches to the two categories. This section will briefly discuss the main approaches. Development of Value-at-Risk for traded Market Risk - Introduction to VaR through a simple example - Very brief outline of its calculation using Historic Simulation - Impact of changing the properties of the portfolio - Look at implementation by international banks - What are some of the basic problems? - Required regulatory infrastructure, including backtesting - Unstressed and Stressed VaR Issuer risk (for historic reasons, often linked to traded market risk) - Introducing the CCR Credit Valuation Adjustment – how to estimate it - Should credit risk and market risk be separated? Development of techniques to assess non-traded Market Risk - How does it arise? - What are the usual measures? - Traditional techniques: banding, gap analysis and duration - Creation of a standardised framework, including cross-currency considerations - Applying simulation Proposals under the Fundamental Review of 2012 - Division between Trading and Banking revisted - Models to be calibrated in times of stress - Assumption of differing market liquidity assumptions - Changes to internal model approval - Replacement of VaR by Expected Shortfall - Movement of non-traded market risk into Pillar 1 - Potential changes to credit risk within the Trading environment Funding Liquidity Risk Funding liquidity risk is closely related to non-traded market risk. Whilst much rarer, it is also invariably much more dangerous. What is Funding liquidity risk – some case studies - What has happened to many banks in last two years - Why was liquidity risk typically ignored - How to address liquidity risk - Creation of an Internal Liquidity Adequacy Standard framework - Basel III Liquidity constraints - Liquidity Coverage Ratio – how it will work - Changes in January 2013 - Net Stable Funding Ratio – how we think it will work - Timetable for implementation Operational Risk It is assumed that all participants are familiar with the concepts of and background to operational risk; these will not be covered. This section will mainly discuss how operational risks are identified and assessed. Creating a risk framework - Risk identification – causal and event frameworks Recording of Loss Events and other data - What should be stored – with a real example - Definition of Loss – direct or indirect? - Build or buy an OR database Risk assessment Process analysis will be briefly discussed: - Which are the key processes – vertical or horizontal? - Process mapping – what are the major risks in any given process? Indicator approaches – what are the key assumptions - Key risk indicators – what can be used as a risk metric? - The KRI project - Regulatory indicator approaches – what is permitted? - Business Efficiency and Internal Control Factors Bottom-up risk measurement models - Loss Distribution Analysis: statistical modelling using historic data - Using external data – good or bad? - Fitting severity and frequency distributions - Modelling a LD, and estimating the 99.9% VaR - Improving such a model - Computer-based demonstration using real data - Control self assessment: Score-card or self assessment approaches - Examples of assessment questionnaires - Training of people to conduct self-assessment - Examples of professional software used to support this methodology - Results from a CSA - Estimation of VaR using simulation and other approaches - Computer-based demonstration Exceptional and unexceptional events - Will the normal modelling capture exceptional events? - If not, what can be done? Case studies: Barings, Societe Generale and Allied Irish Bank Day 4 Other Topics Stress Testing Stress testing has always been seen as a necessary compliment to “normal” risk management. Yet, it has often been perceived by senior management as an irrelevance! This session discusses the attitude towards stress testing before the recent Western banking crisis, what represents good stress testing, and how attitudes have changed more recently. Why stress test? What are the recent lessons? - How was stress testing viewed prior to 2007? - What happens in times of stress? - What constitutes a good stress test? - What are the management messages from stress tests? - Regulatory stress tests: results from European tests Case studies: NatWest Bank and Long-Term Capital Management Other major risk types Many banks claim to be exposed to four major risk types: the three described above plus the elephant in the room – reputational risk!! Reputational risk - What is the definition of reputational risk - Has reputational risk been increasing or decreasing? - What are the major areas of concern – and how can the potential reputational risks be managed - Can reputational risk be assessed? - What is the crisis plan to manage reputational damage Banks are major users of model, especially in the assessment of risks. But the use of models itself involves risks. How are these risks to be identified, assessed and managed? Model Risk and Validation - Suitability of the model – objective, underlying theory, model design, and outputs - Data requirements – observable, reliable, accurate, cleansing - Testing of the model – accuracy, robustness, what happens in times of stress? - Skills of the staff – developers, users, controllers - Governance surrounding the model (and data) – controls, documentation, role of senior management - Maintenance – upgrading, continued validation process Risk and Return The objective of this session is to explore how modern risk management may contribute to the overall strategic development of the institution. In particular, what is the acceptable trade-off between the return on a transaction, and the risk it incurs for the bank? A number of different aspects will be reviewed, and current global “best practice” will be discussed. RAROC: risk-adjusted return on risk-adjusted capital - What is RAROC? How is it defined? Variants such as EVA - Determining the cost of capital using the Capital Asset Pricing Model - The use of RAROC: pricing and performance measurement - Examples of banks having implemented RAROC - Another example of risk-adjusted pricing: - The credit treasury – an example of risk transfer pricing - Actively managing credit portfolios - Calculating incremental and marginal credit VaR using analytic models - Measuring RAROC for an individual transaction - Creating a risk-return frontier - Actively managing the risk profile of the portfolio Final words - Back to EWRM Reminder: what are the objectives of EWRM? - What are the main hurdles to implementation? - Culture and the embedding of risk management - Availability, timeliness and quality of data - Risk quantification - Risk silos – how to aggregate risk measurement? - How can these hurdles be overcome? - Organisational and communicational - Creation of a EW data warehouse - Commonsense and judgement, not models Course summary and close