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1、RiskManagementandBaselIIJaved H SiddiqiRisk Management DivisionBANK ALFALAH LIMITED1“Knowledge has to be improved, challenged and increased constantly or it vanishes” Peter DruckerRisk Management and Basel IIRisk Management DivisionBank Alfalah Limited Javed H. Siddiqi2Managing Risk Effectively: Thr
2、ee Critical ChallengesGLOBALISMTECHNOLOGYCHANGEManagement Challenges for the 21st Century3AgendalWhat is Risk ?lTypes of Capital and Role of Capital in Financial InstitutionlCapital Allocation and RAPMlExpected and Unexpected Loss lMinimum Capital Requirements and Basel II PillarslUnderstanding of V
3、alue of Risk-VaRlBasel II approach to Operational Risk managementlBasel II approach to Credit Risk managementlCredit Risk Mitigation-CRM, Simple and Comprehensive approach.lThe Causes of Credit RisklBest Practices in Credit Risk ManagementlCorrelation and Credit Risk Management.lCredit Rating and Tr
4、ansition matrix.lIssues and ChallengeslSummary4What is Risk?Risk,intraditionalterms,isviewedasanegative.Webstersdictionary,forinstance,definesriskas“exposingtodangerorhazard”.TheChinesegiveamuchbetterdescriptionofriskThe first is the symbol for “danger”, while the second is the symbol for “opportuni
5、ty”, making risk a mix of danger and opportunity.5RiskManagementRiskmanagementispresentinallaspectsoflife;Itisabouttheeverydaytrade-offbetweenanexpectedrewardanapotentialdanger.We,inthebusinessworld,oftenassociateriskwithsomevariabilityinfinancialoutcomes.However,thenotionofriskismuchlarger.Itisuniv
6、ersal,inthesensethatitreferstohumanbehaviourinthedecisionmakingprocess.Risk management is an attempt to identify, to measure, to monitor and to manage uncertainty. 6CapitalAllocationandRAPMlThe role of the capital in financial institutions and the different type of capital.lThe key concepts and obje
7、ctive behind regulatory capital.lThe main calculations principles in the Basel II the current Basel II Accord.lThe definition and mechanics of economic capital.lThe use of economic capital as a management tool for risk aggregation, risk-adjusted performance measurement and optimal decision making th
8、rough capital allocation.7Role of Capital in Financial InstitutionlAbsorblargeunexpectedlosseslProtectdepositorsandotherclaimholderslProvideenoughconfidencetoexternalinvestorsandratingagenciesonthefinancialheathandviabilityoftheinstitution.8TypeofCapitallEconomic Capital (EC) or Risk Capital.Anestim
9、ateofthelevelofcapitalthatafirmrequirestooperateitsbusiness.lRegulatory Capital (RC).Thecapitalthatabankisrequiredtoholdbyregulatorsinordertooperate.lBank Capital (BC)Theactualphysicalcapitalheld9Economic CapitallEconomiccapitalactsasabufferthatprovidesprotectionagainstallthecredit,market,operationa
10、landbusinessrisksfacedbyaninstitution.lECissetataconfidencelevelthatislessthan100%(e.g.99.9%),sinceitwouldbetoocostlytooperateatthe100%level.10Risk Measurement- Expected and Unexpected LosslThe Expected Loss (EL) and Unexpected Loss (UL) framework may be used to measure economic capitallExpected Los
11、s: the mean loss due to a specific event or combination of events over a specified periodlUnexpected Loss: loss that is not budgeted for (expected) and is absorbed by an attributed amount of economic capitalLosses so remote that capital is not provided to cover them. 500Expected Loss,ReservesEconomi
12、c Capital =Difference 2,0000Total Loss incurred at x% confidence levelDetermined by confidence level associated with targeted ratingProbabilityCost2,500ELUL11Minimum Capital RequirementsBasel IIAnd Risk Management12History13ComparisonBasel IBasel 2FocusonasingleriskmeasureMoreemphasisonbanksinternal
13、methodologies,supervisoryreviewandmarketdisciplineOnesizefitsallFlexibility,menuofapproaches.ProvidesincentivesforbetterriskmanagementOperationalrisknotconsideredIntroducesapproachesforCreditriskandOperationalriskinadditiontoMarketriskintroducedearlier.BroadbrushstructureMorerisksensitivity14Objecti
14、veslThe objective of the New Basel Capital accord (“Basel II) is:1.To promote safety and soundness in the financial system2.To continue to enhance completive equality3.To constitute a more comprehensive approach to addressing risks4.To render capital adequacy more risk-sensitive5.To provide incentiv
15、es for banks to enhance their risk measurement capabilities15MINIMUM CAPITAL REQUREMENTS FOR BANKS(SBPCircularno6of2005)IRAF RatingRequired CAR effective fromInstitutional Risk Assessment Framework (IRAF)31st Dec. 200531st Dec., 2006 and onwards1 & 28%8%39%10%410%12%512%14%16Overview of Basel II Pil
16、larsThe new Basel Accord is comprised of three pillarsPillar IMinimum Capital RequirementsEstablishes minimum standards for management of capital on a more risk sensitive basis:Credit RiskOperational RiskMarket Risk Pillar IISupervisory Review ProcessIncreases the responsibilities and levels of disc
17、retion for supervisory reviews and controls covering:Evaluate Banks Capital Adequacy StrategiesCertify Internal ModelsLevel of capital chargeProactive monitoring of capital levels and ensuring remedial action Pillar IIIMarket DisciplineBank will be required to increase their information disclosure,
18、especially on the measurement of credit and operational risks.Expands the content and improves the transparency of financial disclosures to the market.17Development of a revised capital adequacy framework Components of Basel IIPillar 1Pillar 2Pillar 3The three pillars of Basel II and their principle
19、sBasel IISupervisory review processHow will supervisory bodies assess, monitor and ensure capital adequacy?Internal process for assessing capital in relation to risk profileSupervisors to review and evaluate banks internal processes Supervisors to require banks to hold capital in excess of minimum t
20、o cover other risks, e.g. strategic riskSupervisors seek to intervene and ensure complianceMarket disclosureWhat and how should banks disclose to external parties?Effective disclosure of:-Banksriskprofiles-AdequacyofcapitalpositionsSpecific qualitative and quantitative disclosures-Scopeofapplication
21、-Compositionofcapital-Riskexposureassessment-CapitaladequacyMinimum capital requirementsHow is capital adequacy measured particularly for Advanced approaches?Better align regulatory capital with economic riskEvolutionary approach to assessing credit risk-Standardised(externalfactors)-FoundationInter
22、nalRatingsBased(IRB)-AdvancedIRBEvolutionary approach to operational risk-Basicindicator-Standardised-Adv.MeasurementIssuePrincipleContinue to promote safety and soundness in the banking systemEnsure capital adequacy is sensitive to the level of risks borne by banksConstitute a more comprehensive ap
23、proach to addressing risksContinue to enhance competitive equalityObjectives18OverviewofBaselIIApproaches(PillarI)Approaches that can befollowed in determination of Regulatory Capitalunder Basel IITotal Regulatory CapitalOperational RiskCapitalCreditRiskCapitalMarketRiskCapitalBasic IndicatorApproac
24、hStandardized ApproachAdvanced Measurement Approach (AMA)Standardized ApproachInternal Ratings Based (IRB)FoundationAdvancedStandardModel InternalModelScore CardLoss DistributionInternal Modeling19Operational Risk and the New Capital AccordlOperational risk is now to be considered as a fully recogni
25、zed risk category on the same footing as credit and market risk.lIt is dealt with in every pillar of Accord, i.e., minimum capital requirements, supervisory review and disclosure requirements.lIt is also recognized that the capital buffer related to credit risk under the current Accord implicitly co
26、vers other risks.20OperationalriskBackgroundDescriptionThree methods for calculating operational risk capital charges are available, representing a continuum of increasing sophistication and risk sensitivity:(i) the Basic Indicator Approach (BIA)(ii) The Standardised Approach (TSA) and(iii) Advanced
27、 Measurement Approaches (AMA)BIA is very straightforward and does not require any change to the businessTSA and AMA approaches are much more sophisticated, although there is still a debate in the industry as to whether TSA will be closer to BIA or to AMA in terms of its qualitative requirementsAMA a
28、pproach is a step-change for many banks not only in terms of how they calculate capital charges, but also how they manage operational risk on a day-to-day basisAvailable approachesOperational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and syste
29、ms or from external events. This definition includes legal risk, but excludes strategic and reputation risk21TheMeasurementmethodologieslBasicIndicatorApproach:1.CapitalCharge=alphaXgrossincome*alphaiscurrentlyfixedas15%lStandardizedApproach:2.CapitalCharges=betaXgrossincome(grossincomeforbusinessli
30、ne=i=1,2,3,.8)lValue of “Greeks” are supervisory imposed22The Measurement methodologieslBusiness LinesBeta Factors1.CorporateFinance18%2.Trading&Sales18%3.RetailBanking12%4.CommercialBanking15%5.PaymentandSettlement18%6.AgencyServices15%7.AssetManagement12%8.RetailBrokerage12%23The Measurement metho
31、dologieslUnder the Advanced Measurement Approaches, the regulatory capital requirements will equal the risk measure generated by the banks internal measurement system and this without being too prescription about the methodology used.lThis system must reasonably estimate unexpected losses based on t
32、he combined use of internal loss data, scenario analysis, bank-specific business environment and internal control events and support the internal economic capital allocation process by business lines.24Understanding Market RiskIt is the risk that the value of on and off-balance sheet positions of a
33、financial institution will be adversely affected by movements in market rates or prices such as interest rates, foreign exchange rates, equity prices, credit spreads and/or commodity prices resulting in a loss to earnings and capital.25ConvergenceofEconomiesEasyandfasterflowofinformationSkillEnhance
34、mentIncreasingMarketactivityWhy the focus on Market Risk Management ?LeadingtoIncreasedVolatilityNeedformeasuringandmanagingMarketRisksRegulatoryfocusProfitingfromRisk26Measure, Monitor & Manage Value at RiskValue-at-RiskValue-at-RiskisameasureofMarketRisk,whichmeasuresthemaximumlossinthemarketvalue
35、ofaportfoliowithagivenconfidenceVaRisdenominatedinunitsofacurrencyorasapercentageofportfolioholdingsFore.g.,asetofportfoliohavingacurrentvalueofsayRs.100,000-canbedescribedtohaveadailyvalueatriskofRs.5000-ata99%confidencelevel,whichmeansthereisa1/100chanceofthelossexceedingRs.5000/-consideringnogrea
36、tparadigmshiftsintheunderlyingfactors.Itisaprobabilityofoccurrenceandhenceisastatisticalmeasureofriskexposure27Variance-Variance-covariancecovarianceMatrixMatrixMultipleMultiplePortfoliosPortfoliosYieldsYieldsDurationDurationIncremental Incremental VaRVaRStop LossStop LossPortfolioPortfolioOptimizat
37、ionOptimizationVaRFeatures of RMD VaR ModelFacilityofmultiplemethodsandportfoliosinsinglemodelReturnAnalysisforaidingintrade-offForIdentifyingandisolatingRiskyandsafesecuritiesForpickingupsecuritieswhichgelwellintheportfolioForaidingincuttinglossesduringvolatileperiodsHelpsinoptimizingportfoliointhe
38、givensetofconstraints28Value at Risk-VARlValue at risk (VAR) is a probabilistic method of measuring the potentional loss in portfolio value over a given time period and confidence level.lThe VAR measure used by regulators for market risk is the loss on the trading book that can be expected to occur
39、over a 10-day period 1% of the time lThe value at risk is $1 million means that the bank is 99% confident that there will not be a loss greater than $1 million over the next 10 days.29Value at Risk-VARlVAR (x%) = Zx%VAR(x%)=the x% probability value at riskZx% = the critical Z-value = the standard de
40、viation of daily returns on a percentage basisVAR (x%)dollar basis= VAR (x%) decimal basis X asset value30Example: Percentage and dollar VARlIf the asset has a daily standard deviation of returns equal to 1.4 percent and the asset has a current value of $5.3 million calculate the VAR(5%) on both a p
41、ercentage and dollar basis.lCritical Z-value for a VAR(5%)= -1.65, VAR(10%)=-1.28, VAR(1%)=-2.32 VAR(5%) = -1.65() = -1.65(.014) = -2.31% VAR (x%)dollar basis= VAR (x%) decimal basis X asset value VAR (x%)dollar basis= -.0231X5,300,000 = $-122,430 Interpretation:thereisa5%probabilitythatonanygivenda
42、y,thelossinvalueonthisparticularassetwillequalorexceed2.31%or$122,43031Time conversions for VARVAR(x%)= VAR(x%)1-dayJlDaily VAR: 1 daylWeekly VAR: 5 dayslMonthly VAR: 20 dayslSemiannual VAR: 125 dayslAnnual VAR: 250 days32 Converting daily VAR to other time bases: lAssume that a risk manager has cal
43、culated the daily VAR(10%) dollar basis of a particular assets to be $12,500.lVAR(10%)5-days(weekly) = 12,500 5= 27,951lVAR(10%)20-days(monthy) = 12,500 20= 55,902lVAR(10%)125-days = 12,500 125= 139,754lVAR(10%)250-days = 12,500 250= 197,64233Credit Risk ManagementRiskManagementDivisionBankAlfalah34
44、CreditRiskCreditriskreferstotheriskthatacounterpartyorborrowermaydefaultoncontractualobligationsoragreements35Standardized Approach (Credit Risk)lThe Banks are required to use rating from External Credit Rating Agencies (ECAIS).(LongTerm)SBP Rating GradeECA ScoresPACRAJCR-VISRisk Weight (Corporate)1
45、0,1AAAAA+AAAA-AAAAA+AAAA-20%22A+AA-A+AA-50%33BBB+BBBBBB-BBB+BBBBBB-100%44BB+BBBB-BB+BBBB-100%55,6B+BB-B+BB-150%67CCC+andbelowCCC+andbelow150%UnratedUnratedUnratedUnrated100%36Short-Term Rating Grade Mapping and Risk WeightExternal grade (short term claim on banks and corporate)SBP Rating GradePACRAJ
46、CR-VIS Risk Weight1S1A-1A-120%2S2A-2A-250%3S3A-3A-3100%4S4OtherOther150%37MethodologyCalculate the Risk Weighted AssetslSolicitedRatinglUnsolicitedRatingBanks may use unsolicited ratings (if solicited rating is not available) based on the policy approved by the BOD.38Short-TermRatinglShort term rati
47、ng may only be used for short term claim.lShort term issue specific rating cannot be used to risk-weight any other claim.e.g. If there are two short term claims on the same counterparty.1.Claim-1 is rated as S2 2.Claim-2 is unratedClaim-1 rated as S2Claim-2 unratedRisk -weight50%100%39Short-TermRati
48、ng(Continue)e.g. If there are two short term claims on the same counterparty.1.Claim-1 is rated as S4 2.Claim-2 is unratedClaim-1 rated as S4Claim-2 unrated Risk -weight150%150%40Ratings and ECAIslRating DisclosureBanksmustdisclosetheECAIitisusingforeachtypeofclaim.Banksarenotallowedto“cherrypick”th
49、eassessmentsprovidedbydifferentECAIs41Basel I v/s Basel IIBasel: No Risk DifferentiationCapital Adequacy Ratio = Regulatory Capital / RWAs (Credit + Market)8%=RegulatoryCapital/RWAsRWAs(CreditRisk)=RiskWeight*TotalCreditOutstandingAmountRWAs=100%*100M=100M8 % = Regulatory Capital / 100 MBasel II: Ri
50、sk Sensitive FrameworkRWA(PSO)=RiskWeight*TotalOutstandingAmount=20%*10M=2MRWA(ABCTextile)=100%*10M=10MTotalRWAs=2M+10M=12M4243CreditRiskMitigation(CRM)lWhereatransactionissecuredbyeligiblecollateral.lMeetstheeligibilitycriteriaandMinimumrequirements.lBanksareallowedtoreducetheirexposureunderthatpar
51、ticulartransactionbytakingintoaccounttheriskmitigatingeffectofthecollateral.44AdjustmentforCollateral:Therearetwoapproaches:1.SimpleApproach2.ComprehensiveApproach45Simple Approach (S.A)lUnder the S. A. the risk weight of the counterparty is replaced by the risk weight of the collateral for the part
52、 of the exposure covered by the collateral.lFor the exposure not covered by the collateral, the risk weight of the counterparty is used.lCollateral must be revalued at least every six months.lCollateral must be pledged for at least the life of the exposure. 46ComprehensiveApproach(C.A)lUnder the com
53、prehensive approach, banks adjust the size of their exposure upward to allow for possible increases.lAnd adjust the value of collateral downwards to allow for possible decreases in the value of the collateral.lA new exposure equal to the excess of the adjusted exposure over the adjusted value of the
54、 collateral.lcounterpartys risk weight is applied to the new exposure.47e.g.Suppose that an Rs 80 M exposure to a particular counterparty is secured by collateral worth Rs 70 M. The collateral consists of bonds issued by an A-rated company. The counterparty has a rating of B+. The risk weight for th
55、e counterparty is 150% and the risk weight for the collateral is 50%.lTherisk-weightedassetsapplicabletotheexposureusingthesimpleapproachistherefore:0.5 X 70 + 1.50 X 10 = 50 million Risk-adjusted assets = 50 MlComprehensiveApproach:Assumethattheadjustmenttoexposuretoallowforpossiblefutureincreasesi
56、ntheexposureis+10%andtheadjustmenttothecollateraltoallowforpossiblefuturedecreasesinitsvalueis-15%.Thenewexposureis:1.1 X 80 -0.85 X 70 = 28.5 millionAriskweightof150%isappliedtothisexposure: Risk-adjusted assets = 28.5 X 1.5 =42.75 M48Credit riskBasel II approaches to Credit RiskStandardised Approa
57、chFoundationAdvancedInternal Ratings Based (IRB) ApproachesEvolutionary approaches to measuring Credit Risk under Basel IIRWA based on externally provided:ProbabilityofDefault(PD)ExposureAtDefault(EAD)LossGivenDefault(LGD)RWA based on internal models for:ProbabilityofDefault(PD)RWA based on external
58、ly provided:ExposureAtDefault(EAD)LossGivenDefault(LGD)RWA based on internal models forProbabilityofDefault(PD)ExposureAtDefault(EAD)LossGivenDefault(LGD)Limited recognition of credit risk mitigation & supervisory treatment of collateral and guaranteesLimited recognition of credit risk mitigation &
59、supervisory treatment of collateral and guaranteesInternal estimation of parameters for credit risk mitigation guarantees, collateral, credit derivativesBasel II provides a tailored or evolutionary approach to banks that is sensitive to their credit risk profilesIncreasing complexity and data requir
60、ementIncreasing complexity and data requirementDecreasing regulatory capital requirementDecreasing regulatory capital requirement49CreditRiskLinkagestoCreditProcessTransaction Credit Risk AttributesExposure at DefaultLoss Given DefaultProbability of DefaultExposure TermEconomic loss or severity of l
61、oss in the event of defaultLikelihood of borrower defaultover the time horizonExpected amount of loan when default occursExpected tenor based on pre-payment, amortization, etc.CREDIT POLICYRISK RATING / UNDERWRITINGCOLLATERAL / WORKOUTLIMIT POLICY / MANAGEMENTMATURITY GUIDELINESINDUSTRY / REGION LIM
62、ITSBORROWER LENDING LIMITSPortfolioCredit Risk AttributesRelationship to other assets within the portfolioExposure size relative to the portfolioDefault CorrelationRelative Concentration50ThecausesofcreditrisklTheunderlyingcausesofthecreditriskincludetheperformancehealthofcounterpartiesorborrowers.l
63、Unanticipatedchangesineconomicfundamentals.lChangesinregulatorymeasureslChangesinfiscalandmonetarypoliciesandinpoliticalconditions.51RiskManagementRiskManagementactivitiesaretakingplacesimultaneously.Strategic MacroMicroLevel52Best PracticesinCredit Risk ManagementCredit Risk Management1.Rethinking
64、thecreditprocess2.DeployBestPracticesframework3.DesignCreditRiskAssessmentProcess4.Architecture forInternalRating5.Measure, Monitor & ManagePortfolioCreditRisk6.ScientificapproachforLoanpricing7.AdoptRAROCasacommonlanguage8.Explorequantitativemodelsfordefaultprediction9.UseHedgingtechniques10.Create
65、Creditculture53IncreasedrelianceonobjectiveriskassessmentAlign“Riskstrategy”&“BusinessStrategy”Creditprocessdifferentiatedonthebasisofrisk,notsizeInvestmentinworkflowautomation/back-endprocessesActiveCreditPortfolioManagement1.Rethinking thecreditprocess542.DeployBestPracticesframeworkCredit&CreditR
66、iskPoliciesshouldbecomprehensiveSetLimitsOnDifferentParametersCreditorganisation-IndependentsetofpeopleforCreditfunction&Riskfunction/Creditfunction&ClientRelationsAbilitytoCalculateaProbabilityofDefaultbasedontheInternalScoreassignedSeparateInternalModelsforeachborrowercategoryandmappingofscalestoa
67、commonscale553.DesignCreditRiskAssessmentProcessCredit RiskIndustry RiskBusiness RiskManagement RiskFinancial RiskIndustryCharacteristicsIndustryFinancialsMarketPositionOperatingEfficiencyTrackRecordCredibilityPaymentRecordOthersExistingFin.PositionFutureFinancialPositionFinancialFlexibilityAccounti
68、ngQualityExternalfactorsScoredcentrallyonceinayearInternalfactorsScoredforeachborrowingentitybytheconcernedcreditofficerRMDprovideswellstructured“readytouse”“valuestatements”tofairlycaptureandmirrortheRatingofficersriskassessmentundereachspecificriskfactoraspartoftheInternalRatingModel56CreditRating
69、Systemconsistsofallofthemethods,processes,controlsanddatacollectionandITsystemsthatsupporttheassessmentofcreditrisk,theassignmentofinternalriskratingsandthequantificationofdefaultandlossestimates.The New Basle Capital AccordAppropriateratingsystemforeachassetclassMultiplemethodologiesallowedwithinea
70、chassetclass(largecorporate,SME)EachborrowermustbeassignedaratingTwodimensionalratingsystemRiskofborrowerdefaultTransactionspecificfactors(Forbanksusingadvancedapproach,facilityratingmustexclusivelyreflectLGD)Minimumofnineborrowergradesfornon-defaultedborrowersandthreeforthosethathavedefaultedCORPOR
71、ATE/ BANK/ SOVEREIGN EXPOSURESEachretailexposuremustbeassignedtoaparticularpoolThepoolsshouldprovideformeaningfuldifferentiationofrisk,groupingofsufficientlyhomogenousexposuresandallowforaccurateandconsistentestimationoflosscharacteristicsatpoollevelRETAIL EXPOSURES4.Architecture forInternalRating57
72、ONEDIMENSIONALRRMDsmodifiedTWODIMENSIONALapproachRatingreflectsExpectedLossCONCEPTUALLYSOUNDINTERNALRATINGMODELCAPTURESPD,LGDSEPARATELYDiffersfromthetwodimensionalsystemportrayedaboveinthatitrecordsLGDratherthanELasthesecondgrade.ThebenefitofthisapproachisthatratersLGDjudgmentcanbeevaluatedandrefine
73、dovertimebycomparingthemtolossexperience.TheFacilitygradeexplicitlymeasuresLGD.TheraterwouldassignafacilitytooneofseveralLGDgradesbasedonthelikelyrecoveryratesassociatedwithvarioustypesofcollateral,guaranteesorotherfactorsofthefacilitystructure.4.Architecture forInternalRatingcontd.58CREDITCAPITALTh
74、eportfolioapproachtocreditriskmanagementintegratesthekeycreditriskcomponentsofassetsonaportfoliobasis,thusfacilitatingbetterunderstandingoftheportfoliocreditrisk.Theinsightgainedfromthiscanbeextremelybeneficialbothforproactivecreditportfoliomanagementandcredit-relateddecisionmaking.1.It is basedon a
75、 rating(internalratingof banks/externalratings)basedmethodology.2. Being based on a loss distribution (CVaR)approach,iteasilyformsapartoftheIntegratedriskmanagementframework.5.Measure, Monitor & ManagePortfolioCreditRisk59PORTFOLIOCREDITVaRExpected (EL)Priced into the product (risk-based pricing)Une
76、xpected (UL)Covered by capital reserves (economic capital)ProbabilityLoss (L)CreditCapitalmodelstheloss to the valueoftheportfolioduetochangesincreditqualityoveratimeframe60ARECORRELATIONSIMPORTANT0%10%20%30%40%50%60%70%80%90%100%99.99%99.67%99.35%99.03%98.71%98.39%98.07%97.75%97.43%97.11%96.79%96.4
77、7%96.15%95.83%95.51%95.19%CorrelationProbabilityofDefaultConfidencelevelLargeimpactofcorrelationsRELATIVE CONTRIBUTION OF CORRELATIONS AND PROBABILITY OF DEFAULT IN CREDIT VaRCREDITVaRSource:S&P613-Year Default CorrelationsAutoConsEnergFinanBuildChemHi techInsurLeisureR.E.TeleTransUtilityAuto4.811.8
78、41.570.672.683.653.110.672.062.407.043.562.39Cons1.842.51-1.410.832.361.601.690.522.016.032.492.561.31Energ1.57-1.414.74-0.50-0.490.940.750.75-1.630.20-0.44-0.280.05Finan0.670.83-0.501.391.540.520.73-0.031.886.27-0.041.030.67Build2.682.36-0.491.543.812.092.780.413.647.323.853.291.78Chem3.651.600.940
79、.522.093.502.340.412.120.915.212.611.30High tech3.111.690.750.732.782.343.010.472.453.834.632.821.67Insur0.670.520.75-0.030.410.410.4796.000.100.460.501.080.22Leisure2.062.01-1.631.883.642.122.450.104.079.393.513.401.48Real Est.2.406.03-0.206.277.320.913.830.469.3913.15-1.144.782.21Telecom7.042.49-0
80、.44-0.043.855.214.630.503.51-1.1416.725.634.33Trans3.562.56-0.281.033.292.612.821.083.404.785.633.851.99Utility2.391.310.050.671.781.301.670.221.482.214.331.992.07Corr(X,Y)=xy=Cov(X,Y)/std(X)std(Y)62Overall ArchitectureAverage variability explained by each industryIndustry CorrelationStep1Tenor of E
81、valuation, Current RatingCorrelationsTransition ratesStep2Return ThresholdsSimulated Credit ScenariosStep3Monte Carlo simulationMigrationPortfolio Loss DistributionSpot & Forward Curve for each gradeRecovery Rates ValuationStep4ExposureDefaultRMDsapproachCREDITCAPITALSTEP 1From the historical correl
82、ation data of industries, the firm-to-firm correlations are found. STEP 2Calculate asset value thresholds for entire transition matrix. This is done assuming that given current rating, the asset values have to move up/down by certain amounts (which can be read off a Standard Normal distribution) for
83、 it to be upgraded /downgraded.Step 3 Large no. of Simulations (Monte Carlo) of the asset value thresholds preserving the correlation structure using Cholesky Decomposition is carried out. Asset value thresholds are converted to simulated ratings for the portfolio for each of the simulation runs.STE
84、P 4Using the forward yield curve (rating wise) and recovery data suitable valuation of each of the instruments in the portfolio is done for each simulation run. The distribution of portfolio values is subtracted from the original value to generate the loss distribution.637.AdoptRAROCasacommonlanguag
85、eWhatisRAROC?Revenues-Expenses-ExpectedLosses+Returnoneconomiccapital+transfervalues/pricesCapital required forCreditRiskMarketRiskOperationalRiskRiskAdjustedReturnRiskAdjustedCapitalorEconomicCapitalRAROCTheconceptofRAROC(RiskadjustedReturnonCapital)isattheheartofIntegratedRiskManagement.64RAROC22%
86、EVA310Risk-adjustedNetincome1750CapitalCharge1440Risk-adjustedAftertaxincome1.75%AverageLendingassets100000Totalcapital8000Costofcapital18%Risk-adjustedNetincome2.20%NetTax0.45%Totalcapital8.0%AverageLendingassets100000Risk-adjustedincome5.60%Costs3.40%CreditRiskCapital4.40%MarketRiskCapital1.60%Ope
87、rationalRiskCapital2.00%Income6.10%ExpectedLoss0.50%RAROCProfitabilityTreeanillustration658.ExplorequantitativemodelsfordefaultpredictionqCorporate predictor ModelisaquantitativemodeltopredictdefaultriskdynamicallyqModelisconstructedbyusingthehybridapproachofcombiningFactormodel&Structuralmodel(mark
88、etbasedmeasure)qTheinputsusedinclude:Financialratios,defaultstatistics,CapitalStructure&EquityPrices.qThepresentcoverageincludelisted&ECAIsratedcompaniesqTheproductdevelopmentworkrelatedtoprivatefirmmodel&portfoliomanagementmodelisinprocessqThemodelisvalidatedinternally.qDerivationofAssetvalue&volat
89、ilityqCalculatedfromEquityValue,volatilityforeachcompany-yearqSolvingforfirmAssetValue&AssetVolatilitysimultaneouslyfrom2eqns.relatingittoequityvalueandvolatilityqCalculateDistancetoDefaultqCalculatedefaultpoint(Debtliabilitiesforgivenhorizonvalue)qSimulatetheassetvalueandVolatilityathorizonqCalcula
90、teDefaultprobability(EDF)qRelatingdistancetodefaulttoactualdefaultexperienceqUseQRM&TransitionMatrixqCalculateDefaultprobabilitybasedonFinancialsqArriveatacombinedmeasureofDefaultusingboth669.UseHedgingtechniquesInterestRateRiskSpreadRiskDefaultRiskCreditDefaultSwapCreditSpreadSwapTotalReturnSwapBas
91、ketCreditSwapSecuriSecuritizationtizationCreditPortfolioRisksDifferent Hedging Techniques.aswegoalong,theextensiveuseofcreditderivativeswouldbecomeimminent67SampleCreditRatingTransitionMatrix( (ProbabilityofmigratingtoanotherratingProbabilityofmigratingtoanotherratingwithinoneyearasapercentage)withi
92、noneyearasapercentage)CreditRatingOneyearinthefutureCreditRatingOneyearinthefutureC CU UR RR RE EN NT TCREDITCREDITR RA AT TI IN NG GAAAAAAAAAAA ABBBBBBBBBBB BCCCCCCDefaulDefault tAAAAAA87.7487.7410.9310.930.450.450.630.630.120.120.100.100.020.020.020.02AAAA0.840.8488.2388.237.477.472.162.161.111.11
93、0.130.130.050.050.020.02A A0.270.271.591.5989.0589.057.407.401.481.480.130.130.060.060.030.03BBBBBB1.841.841.891.895.005.0084.2184.216.516.510.320.320.160.160.070.07BBBB0.080.082.912.913.293.295.535.5374.6874.688.058.054.144.141.321.32B B0.210.210.360.369.259.258.298.292.312.3163.8963.8910.1310.135.
94、585.58CCCCCC0.060.060.250.251.851.852.062.0612.3412.3424.8624.8639.9739.9718.6018.606810.CreateCreditculture“Creditculture”referstoanimplicitunderstandingamongbankpersonnelthatcertainstandardsofunderwritingandloanmanagementmustbemaintained.Strongincentivesfortheindividualmostresponsiblefornegotiatin
95、gwiththeborrowertoassessriskproperlySophisticatedmodellingandanalysisintroducepressureforarchitecutureinvolvingfinerdistinctionsofriskStrongreviewprocessaimtoidentifyanddisciplineamongrelationshipmanagers69Modernize and innovate Islamic financial system within Shariah boundary to meet customers dema
96、ndContinuousadaptationofIslamicfinancialproducts-isitsustainable?Given that.There is this need to.Confront and resolve issues FastevolutionofIslamicfinancialsystemRisingcompetitionfromwellestablishedandemergingfinancialcentresUntappedpotentialintheindustryContinuouslyreviewregulatoryandlegalframewor
97、ktosuitShariahrequirementsDevelopandstandardizeglobalIslamicbankingpracticespromoteuniformitytofacilitatecrossbordertransactionandglobalconventionequivalenttoISDA,UCPConductindepthresearchandfindsolutiononShariahissuesrelatingtoriskmitigation,liquiditymanagementandhedgingAddressshortageoftalentsinpa
98、rticularfinancialsavvyShariahScholarsandShariahsavvyfinancialpractitionersIssues and Challenges.70Risk Management and Image of a Financial Institution. “ The way that risk is managed in any particular institution reflects its position in the marketplace, the products it delivers and perhaps, above a
99、ll, its culture. “71Effective Management of Risk benefits the bank.lEfficient allocation of capital to exploit different risk / reward pattern across businesslBetter Product PricinglEarly warning signals on potential events impacting businesslReduced earnings VolatilitylIncreased Shareholder ValueNo Gain!No RiskTo Summarise.72
