Bank Risk Management Including Basel II & Basel III Workshop

This course is available as a 5 day comprehensive course. For those delegates who do not require the Basel III Workshop, this can be opted out. Course Overview Financial institutions have been formally managing their risks from inception. But the perception of risk management is fundamentally changing within these institutions. No longer is it seen purely as a control mechanism – but as a critical input into the basic business question: am I earning enough revenue out of this transaction to compensate me for the additional risks I am taking on? This concept permeates all the leading financial institutions. Every transaction needs to be assessed in terms of the increase in risk to the institution, with the assurance that the pricing of that transaction will generate a suitable return. Budgets should be allocated, and performances measured, on the basis of revenue earned per unit of risk generated. Such a risk culture is reinforced by the new Basel Accord, already implemented in some countries and due to be implemented in many more in the next 2-3 years. This requires the banks to allocate regulatory capital against the major components of risk, using either regulatory or, more likely, internal models. In the current economic downturn, many financial institutions lost large amounts of money and had to be assisted by governments. Was this a failure of risk management, and if so, why? This course will discuss what happened, and how some institutions actually came out of the credit crisis with enhanced reputations. This course is designed to provide delegates firstly with a high-level overview of modern risk management, including a breakdown of the new Accord and a comparison with the old one. This is then followed by an in-depth examination of the techniques and management structures used to assess and to control risk, including a detailed discussion on the implementation of Value-at-Risk, which is becoming the de facto standard for measuring risk across all the major classes: market, credit and operational. However, the new proposals, announced in May 2012, may well replace this measure by Expected Shortfall, at least for Market Risk. We will discuss why, and how it may be calculated. This unique course follows closely the proposed structure of the new Accord, and is designed to enhance your knowledge on: 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 timeline How should risk management be organised Estimating the level of Economic Capital required to underpin any transaction, and therefore address the question: how much Economic Capital does an institution require? Analysing the major forms of risk generated by financial institutions, particularly within an 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! As a result of the recent banking crisis in the West, the Accord has evolved into what was called Basel II.5 and is now called Basel III. These significant changes to the Accord, and how they will impact on the business model of your bank, will be discussed in detail. 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? Computer simulations of the latest techniques to model market, credit and operational risk, and discussions about commercially-available software Attend this comprehensive 5 day course and lean: A broad look across risk management The Basel Accord – what is it, and why do we have it? Did the Accord work in the current economic crisis? - Basel II.5 and III – what are the impacts of the proposed changes Development of the ICAAP in preparation for your SReP Creation of a risk framework How risk management should be organized The assessment of market risk using both traditional and modern approaches Just announced – the new proposals for Market Risk following a Fundamental Review Credit portfolio management – why is this the new paradigm? How operational risk is being assessed and managed Stress testing – what went wrong, and how this must be changed!! How can Risk Management add value?? Basel III Workshop Following the Western banking crisis of 2007-9, the Basel Committee on Banking Supervision (BCBS) has issued a number of recommended changes to the Basel II Accord with proposed timetables. These changes are known collectively as Basel II.5 and Basel III. Whilst individual countries do not have to implement these changes, or follow the timetables, it is highly likely that the regulator will require the locally authorised banks to comply in due course. This is a proposal to run a 1-day interactive workshop on Basel III for senior management of commercial banks. The objectives of the workshop are: To outline the proposed changes To discuss why these particular changes have been introduced – what problems are they trying to address? To discuss the likely impact on banks’ business models
Day 1 Risk Management A Brief Historical Background The evolution of banking risk: - Why the old Basle Accord was deemed necessary - G30 report Case Study: Bankers Trust - Why Basel II was deemed necessary - Expected and unexpected losses and the role of capital The evolution of bank risk management - From a cost centre to a strategic competitive weapon The Basel Accord II – a Brief Overview It is assumed that all delegates will have at least heard of the new Basel Accord. This section will summarise its implications for financial institutions, with particular attention to Pillars 2 and 3. Objectives of the new Accord - Application of the Accord – to whom does it apply? - Legal standing of the Accord and national discretions Structure of the new Accord Pillar I: Minimum Capital Requirement - What constitutes bank capital? - Changes to the definition of Regulatory Capital - Changes to the regulatory mix of Capital - Likely implications Pillar II: Supervisory Review Process – its objectives Construction of an ICAAP - an overview with examples - What risks should be covered? - How should the risks be assessed? - The structure of the ICAAP - Changes in focus as a result of Basel III Principle-based supervision – what is meant by this? Pillar III: market disclosure – what are the requirements and some issues - Changes as the result of Basel III - Interaction with other regulatory requirements such as IFRS - Will Pillar III remain? Procyclicality Delegates will be encouraged to discuss the current and planned progress of their institution towards the new Accord. Sound Risk Management Practices Whilst each class of risk has developed its own methodologies, there are some overarching sound practices required to support the overall risk management framework. What is a risk framework? - Aside: the COSO framework – how applicable to banks? Developing an appropriate risk management environment - Typical organisational structure - Roles and responsibilities of each of the parties - Defining the risk appetite of the institution - Factors that may influence a risk appetite - Quantitative and qualitative approaches - Creation of risk management policies and procedures - Risk identification framework - Risk measurement methodologies - Management & control of risks - Reporting & monitoring of risks View of governance after the banking crisis - Comments from the supervisors - Introduction of Bank-Wide Risk Management - What are the likely implications Discussion: With reference to a leading international bank. Delegates will be encouraged to discuss the progress of their institution towards sound practices, and highlight areas of priority Day 2 Market Risk Market risk has changed fundamentally over the past 20 years, with the introduction of Value-at-Risk. These sessions first discuss the main approaches used to control traders at the “desk-top”, and then review in some detail the main approach banks use to calculate their regulatory VaR. The regulatory approaches initially changed very little from the first Basle Accord. However, due to the recent banking crisis, there have been a number of substantive changes. The regulatory methods will be reviewed with example calculations, and the implications of the changes discussed. Introduction What are the main sources of market risk? - Interest rate, foreign exchange, equity and commodity risks Definition of “Trading” Introducing Model Risk Case Study: NatWest Bank Traditional Desk-Top Risk Measurement Adopting a portfolio approach, interest rate risk will be discussed: Construction of classic gridpoint sensitivity reports for a significant portfolio - Extension to incorporate curvature Modern Risk Measures: Value-at-Risk Introduction through a simple 1-factor example - Using historic simulation - Extension to a 2-factor example - Demonstration of more realistic examples - What do banks do in practice? - Practical difficulties of implementation: volatility and correlation, holding period Regulatory Requirements of the Basel Accord The standardised approach - How to estimate the IR capital requirement using maturity bands - How to estimate the IR capital requirement using duration bands - How to estimate the FX, equity and commodity capital requirements - How to incorporate options Specific Risk: inclusion of credit risk from the trading book Internal models – using VaR - Qualitative approval process - Normal and Stressed VaR - Calculation of the regulatory capital for market - Back testing: what is it and how to apply it? Measurement of Interest Rate and Liquidity Risk The new Accord makes a distinction between traded and non-traded market risk. The latter includes Funding Liquidity risk, namely the risk that the bank simply cannot renew its funding. Many instances of this have been seen in 2007-9. Banks apply different approaches to try to assess non-traded and liquidity risk, and this section briefly discusses them. IRR exposure: earnings and economic value approaches Traditional technique: banding and gap analysis Funding Liquidity Risk – how is this being assessed now - Likely implications Simulating the Balance Sheet What does the Accord require? - Example of a standardised framework for estimating capital Discussion: Delegates will be encouraged to discuss the organization of the market risk function within their institution and the main management reports used. Day 3 Credit Risk Banks are traditional credit risk-taking institutions. Hence, through experience, presumably they have developed well-founded mechanisms for managing credit risk? If that is the case, why have the leading international banks fundamentally changed the way in which they view credit risk over the past ten years? And does the Basel Accord support or hinder this new paradigm? Overview – the Traditional View of Credit Risk Management (CRM) Banks as traditional credit taking institutions - The typical credit control process - Traditional credit risk mitigation The effectiveness of the process: does it work? - Level 1 CRM Case Studies: Bankgesellschaft Berlin, Continental Illinois and Credit Lyonnais Modern Credit Risk Management Portfolio Credit Risk Management – why is it the new paradigm? What are the fundamental concepts? Basic data requirements: Exposure At Default, Probabilities of Defaults, Loss Given Defaults and correlations How to estimate EADs and EPEs - Traditional loan exposures - Provision of guarantees such as stand-by Letters of Credit or Trade Finance - Settlement, pre-settlement and derivative risks - The concept of credit conversion factors - The concept of Expected Positive Exposure How to estimate PDs: - Using historic internal data - Supplementing with external data - Incorporating the economic cycle Factor-based statistical modelling such as scoring - Examples of factor models - Why are factor models better than naive historic models - How to assess PDs from statistical models Traditional credit analysis – can this be used as well? - What are the main components of a traditional rating methodology Credit analysis vs. statistical modelling? What is the verdict? - Market-based approaches will be discussed very briefly: - The credit market - The debt market - The equity market and Merton’s model - Hybrid models Each approach will be briefly and yet critically discussed How to estimate LGDs: - Is estimating LGDs hard? - Discussion of some estimation projects Seven levels of credit risk management – where is your institution? - Active credit portfolio management Dicussion: Delegates will be encouraged to discuss the organization of the credit risk function within their institution and the main management reports used. Estimation of Regulatory capital for credit risk The Standardised approach - The “who” and the “what” of the Accord - The role of external rating agencies - International or domestic – that’s the question? - Will this role continue – impact of the Dodd-Frank Act of 2010? - Credit Conversion Factors - Permitted risk mitigation Overview of the Internal Rating-Based approaches - Foundation and Advanced approaches - What you supply, what the Accord supplies, and what the National Supervisor supplies - What is likely to change in the future? - How to apply to different client sectors - Example calculations - What is the regulatory credit model? - The underlying theoretical assumptions - Minimum organizational and technical requirements to implement these approaches - Permitted risk mitigation Revisions made in 2005: - Redefinition between Banking and Trading - Double defaults - Minimum maturity - Hedging banking exposures with trading derivatives - CCFs for derivatives Revisions made in 2010 - Introduction of a Leverage constraint - Changes to traded Counterparty Credit Risk - Introduction of the Credit Valuation Adjustment A Brief Outline of Portfolio Credit Modelling Analytically modelling portfolio default assuming independence - Simulating portfolio default - Introducing correlations - Estimation of correlations Modelling a realistic portfolio - Construction of a loss distribution - Calculating credit VaR - Implementing such a model in practice Extension of the default model to a migration model – as required by IRC - This session will be supported by computer demonstrations. If there is time and desire, the events and strategies underlying the credit crisis will be discussed – with case studies on the US Investment Banks and Sachsen LB. Day 4 Operational Risk The Basel Accord has introduced a capital requirement for Operational Risk for the first time. But what is Operational Risk? Can it be realistically measured as the Accord requires? Or is the whole topic the triumph of optimism over reality? These are some of the basic questions to be debated in the section, along with a detailed coverage of the approaches banks are employing. Overview What is operational risk: alternative definitions? - What is the regulatory charge supposed to cover? The Basel categories and definitions - The results of the latest Loss Data Collection Exercise Why has OR been included in the new Accord? - The early view of OR, and the current view Case Study: Royal Bank of Canada Developing an OR Methodology Developing suitable objectives and policies - Role and responsibility of senior management Typical OR organisational structures - Relationship with other functions, especially Internal Audit Top down or bottom up – a major decision? 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 Where is current best practice, and what are the leading institutions doing? - Results of QIS3 (2004) and QIS5 (June 2006) Summary: will it work? Discussion: Delegates will be encouraged to discuss the organization of the operational risk function within their institution and the main management reports used. 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. Definition of stress testing How were stress tests conducted prior to 2007 – what lessons can be learnt? Case study: LTCM How stress tests should be conducted - Role of the Board What is current practice after the banking crisis? How does Risk Management add Value? 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: - Ex ante: allocating economic capital to business units - Ex post: performance measurement - Implementing RAROC: what are the practical problems? Final words - How can risk management add value to the organisation? - Risk management of the future Day 5 Basel III Workshop Why did the Western Banking Crisis Occur? A very brief summary of the deficiencies in Basel I How many banks arbitraged Basel I Why did this lead to the Western banking crisis? How did this lead to the specific changes under Basel III? What are the Major Changes under Basel III? Brief overview of changes to Regulatory Capital - Was Basel II capital truly loss absorbent? - Concept of “going” and “gone” concerns - Outline of changes to the definition - Regulatory adjustments - Conservation Capital Buffer - Counter-Cyclical Capital Buffers - Global and other SIBs - Final percentages and the transition timetable - What is the overall likely impact on the banking business model Brief overview of changes to Credit and Market Risk - Introduction of the Incremental Risk Charge - Introduction of the Credit Valuation Adjustment (CVA) - Introduction of Stressed VaR Multi-Dimensional Risk Measures - Is capital the only mitigant? - Introduction of a leverage constraint - What is proposed – how is it likely to work? - The overall timetable for parallel running and future calibration - Introduction of a Liquidity Framework - Estimation of the Liquidity Coverage Ratio - What are eligible liquid assets? - Estimation of run-offs - Estimation of the Net Stable Funding Ratio - Proposed calibration# - The supervisory stress test - Regulatory metrics to estimate liquidity Stress Testing - 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? - Senior management responses to stress tests - Regulatory stress tests: results from European tests Other changes to Pillars 2 and 3 - Increased focus with Pillar 2 - Changing emphasis for the ICAAP - How the SReP may be adjusted - Revised disclosure requirements under Pillar 3 - Treatment of Systematically Important FIs (SIFIs) - Changes to margining - Possible changes to accounting provisioning What other lessons can we learn from the recent events? - Challenges to corporate governance - Effective and ineffective risk management - Lessons for the senior management - Lessons for the risk managers - Firm-wide risk management - What may happen to the Accord? What is the likely impact on the business models of commercial banks? Course summary and close