The perception of risk management is fundamentally changing within today's institutions. It is no longer 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? 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. Such a risk culture is reinforced by the new Basel Accord, due to be implemented in many countries by the end of the decade. This requires the banks to allocate regulatory capital against the major components of risk, using either regulatory or, more likely, internal models.
This 5-day school is designed to provide you with a high-level overview of modern risk management, including a breakdown of the new Accord and a comparison with the old one. This will then be followed by an in-depth examination of the techniques and management structures used to assess and 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.
In the current economic downturn, many financial institutions have lost large amounts of money and have needed to be assisted by governments. This course will address the crutial question of, was this a failure of risk management, and if so why?
How will this course assist you?
This 5-day course will discuss the credit crisis, and consider how some institutions actually emerged with enhanced reputations. The programme follows the proposed structure of the new Accord, and is designed to enhance your knowledge on:
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Why risk management has become so crucial to financial institutions
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What decisions you need to make when implementing the new Accord and in what time frame
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The level of economic capital required to underpin any transaction
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What are the competing internal approaches to the measurement of credit risk
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What methodologies for operational risk measurement are becoming industry-standard
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Does modelling work: how to mitigate the really big events that may bring you down
Who Should Attend?
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Heads of Risk Management
- Risk Analysts
- Heads of Project Finance
- Financial Analysts
- Portfolio Managers
- Treasury Managers
- Credit Managers
- Rating Agency Analysts
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 II and III.
- 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?
- 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
- Principle-based supervision – what is meant by this?
- Pillar III: market disclosure– what are the requirements and some issues
- Interaction with other regulatory requirements such as IFRS
- Will Pillar III remain?
- Procyclicality
- What has resulted from the banking crisis in 2007-9
- Has the Accord failed?
- Known and likely changes to the Accord
Delegates will be encouraged to discuss the current and planned progress of their institution towards the new Accord.
Sound risk management practices
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?
- 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 and control of risks
- Reporting and monitoring of risks
Case study: 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 the main approach banks use to calculate their regulatory VaR. 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
- 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
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
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?
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?
- Extensions to market-risk framework from 2005 and 2008
- Definition of “trading”
- Valuation of illiquid positions
- Introduction of the incremental risk charge – what are its implications?
- Likely further developments
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.
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 discusses them.
- IRR exposure: earnings and economic value approaches
- Traditional technique: banding and gap analysis
- Applying simulation
- What does the Accord require?
Delegates will be encouraged to discuss the organisation of the market risk function within their institution and the main management reports used.
Day 3
Credit risk
Banks are traditional credit risktaking 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 I 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
- Traditional loan exposures
- Provision of guarantees such as standby letters of credit or trade finance
- Settlement, pre-settlement and derivative risks
- The concept of credit conversion factors
How to estimate PDs:
- Traditional credit analysis. What are the main components of a traditional rating methodology
- Statistical modelling such as scoring
- Examples of statistical models
- How to assess PDs from statistical models
- Credit analysis vs. statistical model? What is the verdict?
- Use of historic data from external parties
- Market-based approaches:
- The credit market
- The debt market
- The equity market and Merton’s model
- Hybrid models
- Each approach will be briefly but 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?
Delegates will be encouraged to discuss the organisation 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?
- Credit conversion factors
- Permitted risk mitigation
Overview of the internal ratingbased 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 organisational 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
Potential revisions made in 2009
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
Extension of the default model to a copula model
Delegates will be given a computerbased example of a portfolio model, to investigate the impact of changing a range of input parameters. If there is time and desire, the events underlying the credit crisis will be discussed.
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 operational risk been included in the new Accord?
- The early view of operational risk, and the current view
Case study: Royal Bank of Canada
Developing an operational risk methodology
- Developing suitable objectives and policies
- Typical operational risk 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 operational risk 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
- Using external data – good or bad?
- Fitting severity and frequency distributions
- Modelling a LD, and estimating the 99.9% VaR
Computer-based demonstration using real data
- Control self assessment: score-card or self-assessment approaches
- Example of assessment questionnaire
- 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
Computer-based demonstration
- An extension: network (or causal) modelling
- Exceptional and unexceptional events
- Will the normal modelling capture exceptional events?
- If not, what can be done?
Case studies: 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
Should time permit and the delegates desire it, the following topics may also be discussed.
Legal risk
Legal risk is deemed to be an integral part of operational risk and is yet often managed completely separately. This session debates the different forms of legal risks, and asks how the operational capital may be assessed.
Accounting and tax risk
Traditionally these risks have remained the remit of the financial function, away from the prying eyes of risk management. Should that remain, or should accounting and tax risks simply form another component of operational risks.
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.
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?
Final words
- How can risk management add value to the organisation?
- Risk management of the future
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