International School of Bank Risk Management

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. International School of Bank Risk Management - Paris The Euromoney bank risk management school 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. This unique course follows closely the proposed structure of the new accord, and is designed to enhance your knowledge of: 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 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! 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
Day 1 Risk management introduction The evolution of banking risk: Why the old Basel Accord was deemed necessary G30 report Case study: Bankers Trust Why the new Basel Accord 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? Structure of the new accord Pillar I: calculation of bank capital for the three classes of bank risk What constitutes bank capital? Pillar II: the supervisory review – its objectives and some unresolved problems Pillar II: interest rate risk – why is this included under this pillar? Pillar III: market disclosure – what are the requirements and some issues Interaction with other regulatory requirements such as IAS The joint forum – what is its role? Alternatives to the accord 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 function. 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 Creation of risk management policies and procedures Risk identification framework Risk measurement methodologies Management & control of risks Reporting & monitoring of risks The discussion will be 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 15 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 alternative approaches to calculating VaR. The permitted regulatory approaches have not changed from the first Basel Accord. Each of the methods is reviewed with example calculations. Introduction What are the main sources of market risk? - Interest rate, foreign exchange, equity and commodity risks What are the main methodologies? 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 Use of sensitivities to construct hedges A brief overview of the option greeks Theta, funding and liquidity risks Modern risk measures: value-at-risk Introduction through a simple 1-factor example Using historic simulation Assuming normality? Using a delta approximation Extension to a 2-factor example Demonstration of more realistic examples Practical difficulties of implementation: volatility and correlation, holding period Stress testing Why stress test? What constitutes a good stress test? Stress testing in practice: how to construct, frequency, organisational level What are the management messages from stress tests? Traditional risk management Limit and control schemes Case study: Long term capital management 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 Calculation of the regulatory capital for market and specific risk Back testing: what is it and how to apply it? Delegates will be encouraged to discuss the organization of the market risk function within their institution and the main management reports used. Measurement of interest rate risk The new accord makes a distinction between market risk and IRR arising from the banking book. Some banks apply different approaches, and this section briefly discusses them.! IRR exposure: earnings and economic value approaches Traditional technique: banding and gap analysis Applying simulation What does the accord require? Case study: MG 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: 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 Exposure at Default 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: Probabilities of defaults, loss given defaults and correlations How to estimate PDs: Traditional qualitative credit rating systems What are the main components of a traditional rating methodology Statistical models such as Z-scores Use of historic data from external parties Market-based approaches: The credit market – example: CreditGradesTM The debt market – example: KamakuraTM The equity market and Merton’s model – example: KMVTM Hybrid models Each approach will be briefly and yet critically discussed How to estimate LGDs Discussion of some estimation projects An outline of portfolio credit modelling Example of a migration approach Modelling for a single obligor Extending to a portfolio – calculating Credit VaR Implementing the model in practice Estimation of correlations Link between asset correlations and default correlations Criticisms of the migration models, and a brief overview of more modern approaches Seven levels of credit risk management – where is your institution? 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? The concept of 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 Results of the BIS QIS5, June 2006 Revisions made in 2005: Redefinition between banking and trading Double defaults Minimum maturity Hedging banking exposures with trading derivatives CCFs for derivatives 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 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 Build or buy an OR database Process analysis – which are the key processes? Process mapping – what are the major risks in any given process? Key risk indicators – what can be used as a risk metric? The KRI project Regulatory indicator approaches – what is permitted? Bottom-up risk measurement models Loss distribution analysis: statistical modelling using historic data Fitting severity and frequency distributions Modelling a LD, and estimating the 99.9% VaR Control self assessment: score-card or self-assessment approaches Example of assessment questionnaire Examples of professional software used to support this methodology Estimation of VaR using simulation Network (or Causal) modelling Exceptional and unexceptional events Case study: Barings and Allied Irish Bank Exposure management – internal mitigation and insurance Risk reporting Where is current best practice, and what are the leading institutions doing? Results of QIS3 (2004) and QIS5 (June 2006) Summary: will it work? Various Case Studies, including BCCI, Daiwa and First National Bank of Keystone Delegates will be encouraged to discuss the organization of the operational risk function within their institution and the main management reports used. Day 5 Beyond the accord: 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.! Revisiting: the concept of economic capital The setting of economic capital Integrating stress testing with economic capital 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 How correlations and marginal risk contribution can be integrated into RAROC Implementing RAROC: what are the practical problems? Risk management of the future Course summary and close