RVMS (Risk and Value Measurement Services)

EDHEC
Financial Regulation
2021

Confidentiel

March 2021

Guillaume KALAYDJIAN
Contents 1
2
PwC
Contexte 6
3

3 Bâle III 12
4 Risques de Pilier I 16
4.1 Risque de marché 17
4.2 Risque de crédit 21
4.3 Risque de crédit de contrepartie 29
5 Asset Liability Management (ALM) 33
6 Mécanisme de Supervision Unique (MSU) 43
7 Targeted Review of Internal Models (TRIM) 47
8 Supervisory Review and Evaluation Process (SREP) 49

PwC 2
Contexte

Contexte

PwC 3
Why banks need to be regulated ? (1/2)
A credit institution, under French law, is a legal person that carries out banking transactions as a regular occupation. Banking
operations include
1) Receipt of funds from the public;
2) Credit transactions;
3) Making available to customers or managing means of payment.
Level of
Assets Liabilities outstanding lost
assets
What would happen if the bank lost the outstanding
Interbank amounts at the levels corresponding to cases 1, 2 and 3?
borrowing
Interbank loans
Case 1: The bank will be able to absorb the level of loss
with its own funds.
Customer
deposit Case 2: The bank will no longer be able to absorb the
Customer
Case 3 level of loss with its own funds. Part of the losses will
loans
be borne by the debt investors.
Miscellaneous
Case 3: Even its deposit customers will have to bear the
Miscellaneous
Certificates of credit losses.
deposit
Securities How could a bank cope with a severe deposit outflow?
portfolio Case 2
Bonds What would happen if the bank could not cope with this
illiquidity crisis?
Case 1
Equity
Fixed assets

PwC 4
Why banks need to be regulated ? (2/2)

Thus, one of the main objectives in regulating a bank is to strengthen the bank's solvency in order to avoid its default, but
above all to avoid the negative impacts on the market and customers that its default would have.

One of the ways of strengthening a bank's solvency is to require an adequate level of capital
corresponding to its risk profile.

Types of losses that can be mitigated by equity capital

1. Losses related to unfavourable movements in asset prices to which the bank is exposed (market risk),
2. Credit losses (credit risk),
3. Losses generated by the default of one or more counterparties (counterparty credit risk),
4. Losses related to operational risk (operational risk).

Strengthening is one of the means to mitigate the risks to which a bank is exposed. There are also other means of ensuring
a bank's solvency and the soundness and stability of the banking system, e.g. provisioning for risks, strengthening the
management of the risk profile, etc.

In order to be able to cope with a liquidity crisis, a bank must either have the means to finance itself
from the market within a short period of time or keep at its disposal a portfolio of securities that can
be easily resold to the market.

To do so, a bank must have a system to steer its liquidity risk profile and monitor its potential funding capacity, especially
its funding capacity in the event of a crisis. (Asset Liability Management, ALM)

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2 Contexte

Trading book vs Banking book

Within a bank, there are 2 categories of books :

1) Trading book : assets held with short term trading objective, or to hedge assets in the trading book
2) Banking book (credit portfolio) : Assets not in the trading book: assets with longer term maturities and held until maturity. For
example, loans, borrowings, deposits etc.

Financial asset
Trading book Banking book (credit portfolio)

Counterparty Liquidity Interest rate

Market risk Credit risk FX risk
credit risk risk risk

The risk of loss due

to changes in asset The risk of loss
The risk of loss
prices. This risk can caused by the The lack of The risk of loss The risk of loss
caused by
be caused by the contractual liquidity to due to the due to the
borrower /
variation of the commitment not honor the change of change of FX
debtor
share price, the honored by the commitment. interest rates rates
insolvency.
interest rate, the counterparty.
exchange rate etc.

The classification of a financial asset in the trading book or the banking book depends on the purpose of the use and the nature of the asset. The allocation of
assets to the trading book and banking book has a direct impact on risk management and the calculation of regulatory capital.
This border and the rules for transferring instruments between the 2 books will be stricter within the framework of the FRTB, ie Fundamental Review of the
Trading Book, presented later in the presentation.

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2 Contexte

Accounting issues – Changes with IFRS13

Fair Value vs. Amortized Cost

Framework IAS 39

Financial assets

Asset held in Fair Value Asset Held To Maturity

Available for Sale (AFS) Loans & Receivables (L&R)
(FV) (HTM)

Fair Value Amortized Cost

The IFRS 13 standard « Fair Value evaluation» , which is to be used since 2013, completed the IAS 39 standard and brought
changes and details:
• No modification of accounting rules of financial instruments
• But changes in the valuation methodologies, notably incorporation of credit and debit risk

IAS 39 IFRS 13
Amount for which an asset could be traded or a liability Price that would be received for the sale of an asset or
settled, between knowledgeable and willing parties, in an paid for the transfer of a liability in a normal transaction
arm's length transaction. between market participants on the valuation date

Mandatory to account for the counterparty credit risk and the own debit risk
There is a symetry between prices

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2 Contexte

Enjeux comptable – Changement avec IFRS13

IFRS 13 reinforces the requirements for including credit risk in the measurement of derivatives at fair value. This leads to complex subjects
combining accounting, economic and methodological issues. Many issues arise regarding the publication of complex elements in the financial
statements.

Fair value (including credit risk) = Fair Value (without credit risk) - CVA +DVA

Liste of main new information required by IFRS 13

• Description of fair value production:

o processes aspects related to governance (organization in committees, distribution of roles),
o aspects related to internal reporting,
o the controls carried out at fair value (value monitoring, calibration method, back-testing, etc.),
o the principles for selecting non-observable parameters and verifying the prices used.
• Qualitative description of the sensitivity of the JV to unobservable data and the correlation effects between
these data
• Principles of transfers between fair value classification levels
• Quantitative information on significant unobservable inputs
o Presentation of the intervals and average of parameters,
o Identification of recovery techniques using these data.
• Justification for the recognition of a Day-One Profit / Loss
• Reasons for a non-recurring fair value measurement

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Accounting issues: Changes with IFRS 13
CVA = EPE PDCpty LGDCpty
0.6

0.4

0.2

0 EPE = Future positive

random paths.
0 5 10 15 20 25 30
-0.2

-0.4

Future random paths of the -0.6

Used for the calculation of the
derivative valuation -0.8

-1 CVA
0.6 -1.2

0.4

0.2

-0.2
0 5 10 15 20 25 30
DVA = ENE PDPropre LGDPropre
-0.4

-0.6

-0.8

-1

-1.2 ENE = Future negative

random paths

Used for the calculation of the

DVA

Fair Value (including credit risk) = Fair Value (without credit risk) - CVA +DVA

9
 Introduction to XVA for derivatives

More generally, we talk today (since 2013) of XVA (a lot of accounting fair value adjustments).
Each bank uses its own methodologies to determine these adjustments
Among those, there are:
❑ CVA/DVA (cf previous slide)
❑ FVA (Funding Valuation Adjustment)
To account for the funding risk for non collateralised derivatives (funding Bor+Spread vs Bor curve)
In general, banks decompose FVA in adjustment for own credit risk (DVA) + adjustment for liquidity risk. It
allows to avoid double counting with DVA.

❑ LVA (Liquidity Value Adjustment)

❑ KVA (Capital value Adjustment)

10
IAS 39 – The accounting standard applied until 31.12.2017..

IAS 39, an impairment model based on incurred losses

Portfolio of loans

Sensitives
Healthy Impaired loans
(incurred but not reported)

NA Collective provisions Specific provisions (individual)

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.. And replaced by IFRS 9 standards
Key elements of the 3 phases of IFRS9 and modalities of the transition

The IASB has published in 2014 the final version of IFRS 9, ‘Financial instruments’ which entered
into application on Jan 1st, 2018 and replaces IAS 39 standard. It contains 3 phases :

IFRS 9 Phase 1 IFRS 9 Phase 2:

• 3 accounting categories : Amortized cost, FV • IAS 39 ‘Too little too late’ : set up of a Expected
OCI or FV P&L Credit Losses Model (‘ECL’ )
Classification Replacement of
• 2 criterias of classification : management and the impairment • Provisioning of the EL at 1Y since the origination of
methods (business model) defined by the company measurement of model with a a new asset
and characteristics of its contractual cash flows financial assets expected credit
and liabilities losses model • Provisioning of EL until maturity in case of
(SPPI)
significant degradation of the credit risk

Modification of hedge
accounting principles

IFRS 9 Phase 3
• Ability to choose the new standard on IFRS9 micro-hedging transactions
while continuing to use the IAS 39 Carve-Out system in macro-hedging
• IFRS9 on micro-hedging transactions widens the possibilities of hedging
strategies for banks.

See R.Herfray course on Credit risk for more details on IFRS 9 application

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Basel III

From Basel I to Basel III ..

Présentation ENSTA
PwC 13
Basel I

The Basel agreement of 1988 placed the Cooke ratio at the heart of its dispositive.

It requires that the ratio of regulatory capital of a credit institution to all of the institution’s risk
weighted assets cannot be less than 8%.

This means that when a bank lends € 100 to a customer, it must have at least € 8 of capital and use a
maximum of € 92 from its other sources of financing such as deposits, loans, interbank financing, etc.

The agreement defined regulatory capital and all credit commitments.

Fonds propres
> 8%
Engagements de crédits

14
Basel I

In the numerator of the ratio : Regulatory capital in the broad sense

• Capital and reserves (basic equity)
• Additional equity considered as "quasi-capital": subordinated debt (debt whose repayment occurs only
after that of all other debts).

In the denominator of the ratio : Credit commitments

• All of the bank's credit commitments were covered, with certain adjustments: Certain credits were
weighted at values less than 100% depending on the nature / type of credit or counterparty.
o Credits guaranteed by a mortgage weighted at 50
o Banking counterpart, international organization or non-OECD State at 20%
o counterparty = OCDE state@ 0%
o Commitments less than one year, not taken into account

Two main limits

• Weighting of credit commitments insufficiently differentiated to reflect the different effective levels of
credit risk.

• The 1990s saw the emergence of a new phenomenon, namely the explosion of the derivatives market and
therefore "off-balance sheet" risks

15
Basel II

The New Basel Prudential Agreement of 2004, or “Basel II”, aimed to better assess
banking risks and to impose a system of prudential supervision and transparency.

Bâle II requires :
• A capital ratio (pillar 1)
• A prudential supervision (pillar 2)
• Financial communication and information (pillar 3)

16
 Basel II : Pillar 1 – Capital ratio

This ratio keeps the level of regulatory capital covering the risks incurred unchanged at 8%. But :
• Calibration according to the risk required.
• Introduction of operational risks (fraud and errors)
• Better appreciation of credit and counterparty risks

McDonough ratio:
Bank Capital > 8% [ credit risk + market risk + operational risk ]

Tier I Capital

Tier II Capital

Tier III Capital

>8%

Credit Operational
Market risk
risk risk

A
BI ST
SA IRB SA IMA M
A A
A
17
Basel II : Pillars 2 & 3

Pillar II : The prudential supervision procedure

• Encourage banks to develop techniques for managing their risks and their level of equity,
• Allow regulatory authorities to increase regulatory capital requirements when necessary.

This requirement must be applied in two ways:

1/ Back testing : Prove the validity of statistical methods (periods of 5 to 7 years)
2/ Stress testing : Prove the validity of capital level in the event of economical crises.

Depending on these results, the regulator may impose the need for additional capital.

Pillar III : Financial communication and information

The logic behind this pillar 3 is that improving financial communication makes it possible to strengthen market
discipline, seen as a complement to the action of the supervisory authorities.

Information is made available to the public on assets, risks and their management. Practices must be transparent
and standardized.

18
Limits of Basel II
Limits of Basel II

• No treatment of all risks (liquidity for example)

• Procyclicality :
• In times of financial euphoria, the weighted risks decrease (because based on the history of
losses), banks need less capital.
• When the situation deteriorates, they must increase their capital to meet the solvency
requirements, with funds becoming scarcer and more expensive, thus helping to precipitate the
banks in a state of "financial suffocation"

• Issues in the market risk capital ratio

• Especially for the most complex products (in particular securitization and re-securitization). The
level of equity was found to be out of step with the reality of the risks involved.

• Problem of rating agencies

• Reduction of capital requirements with internal approach

20
Basel III

In general, the main question raised is that of the relationship between the level of capital of
financial institutions and the risks incurred by their activities (subprime, for example).

Concretely, more or less risky assets were financed with very little or no equity. What is called "leverage" then
made it possible to obtain very high profitability.

Idea of the Committee:

• More equity
• Better quality equity
• More transparency

Five main measures are put forward by the Basel Committee:

1. Increase in equity
2. Introduction of a « counter-cyclical cushion »
3. Introduction of liquidity ratios
4. Implementation of a leverage ratio
5. Systemic risk reduction

21
Bâle III
1. Increase in equity
• Quality improvement
Improve the quality of the “hard core” of bank capital, the “Core tier 1”. By allocating more and better capital.
• Increase in ratios
• Hard capital ratio drops from an equivalent of 2% to 7% of the weighted assets: increase to 4.5% of the
Tier 1 "core" and creation of a similar conservation buffer set at 2 , 5%. Tier 1 ratio drops from 4% to 6 %

2. Introduction of a “contra-cyclical cushion”

• imposed at the discretion of the national regulator; from 0% to 2,5% of the capital.

3. Introduction of liquidity ratios

• The « liquidity coverage ratio » (LCR), short-term ratio, which aims to oblige banks to permanently maintain
a stock of liquid assets to support an acute crisis for 30 days.
• The « net stable funding ratio » (NSFR), a long-term ratio, as a structural complement to the short-term ratio,
compares the stable funding available and the stable funding required over 1 year.

4. Implementation of a leverage ratio

• A simple, transparent, non-risk-based measure that is calibrated to serve as a credible complementary
measure to risk-based capital requirements” (Press release of July 26, 2010).
• Under pressure from the United States, which has long used the leverage ratio with a standard of 4%, is
integrated into pillar 1, with a temporary standard of 3%.
• Defined by the ratio of capital over the balance sheet total.

5. Réduction du risque systémique

• Régulation renforcée pour les institutions financières d’importance systémique : les SIFIs (Systemically
Important Financial Institutions) et les Global SIFIs (Too Big to Fail)
22
Basel III
Basel III aims to promote a more resilient banking sector in the face of shocks. To this end, the Committee is proposing numerous changes
encompassing various subjects, such as the increase, in quantitative as well as qualitative terms, of capital or the strengthening of the risk hedging
framework.
Still in the logic of increasing the resistance of the banking sector, the Committee has set up counter cyclical cushions, allowing protection of the system
in times of significant stress, as well as standards for banks, guaranteeing a stable level of funds. short- and medium-term plans and protection against
liquidity risk.
Structure de Bâle III

Pillar 1 Pillar 2 Pillar 3

Strengthening capital Strengthening the internal Strengthening the financial Introduction of new ratios
requirements in quantity and risk management communication and
quality information

• Strengthening the internal • Improved transparency ▪ Leverage ratio: additional

▪ Maintaining the minimum allocation of equity capital regarding all the risks the measure compared to capital
capital at 8% of RWA * taking by including the risks not bank faces standards
into account market, credit covered in the first pillar: • Strengthening market
and operational risk the overall interest rate risk, discipline ▪ Liquidity ratios: ensuring
▪ Strengthening the quality the liquidity risk and the that banks have sufficient
of capital by defining 2 concentration risk liquidity and stable sources of
possible categories of capital • Improvement of the risk funding
control process
▪ Introduction of • Regulatory controls ▪ Large exposures ratio: avoid
countercyclical cushions the risk of default linked to a
high level of exposures

Strengthening of the 3 pillars New rules

RWA (Risk Weight Asset), correspond to the inimum amount of capital required within a bank or other financial institutions according to their level of risk.

RWA total = RWA Market risk + RWA Credit risk + RWA Operational risk

PwC 23
Reinforcement of capital requirements - Pillar I

One of the major objectives of Basel III is to increase capital, both in terms of quality and quantity. Indeed, the latter must protect the bank in
the event of a significant loss.

Capital
requirements
Tier1 capital (6%)

Tier1 capital is the basic capital of a bank, it mainly includes equity, retained earnings and
CET1 (4.5%) "disclosed reserves". Its level must be greater than or equal to 6% of the RWA.
▪ Core Equity Tier1 (au 4.5 % du RWA) : is made up primarily of shares and other disclosed
reserves, as well as regulatory capital adjustments.
▪ Additional Tier1: is made up of subordinated securities, fully discretionary or non-
discretionary dividends and coupons and perpetual without any incentive to buy back
Additional Tier1
Total capital

Tier2 Tier 2 Capital : include hybrid capital instruments, provisions for impairments, revaluations
as well as undisclosed reserves.
(8%)

Excessive credit growth followed by a slowdown can lead to massive losses in the financial
sector. A vicious circle then ensues when losses from the banking sector pass through to the real
Countercyclical economy and then pass through to the banking sector.
buffer (2.5%)
The purpose of countercyclical buffers is to protect the banking sector by ensuring that capital
requirements take into account the macroeconomic environment in which the bank operates.
They must reach 2.5% of RWA by January 2019.

PwC 24
Focus on the new introduced ratios
However, the Committee remains aware that increasing and improving capital requirements is not enough to protect the financial sector
from shocks. To this end, the Committee also introduced a standard on leverage, liquidity and major risks in order to improve the overall risk
management in financial institutions.

The leverage ratio has two main objectives:

Leverage 𝑇𝑖𝑒𝑟 1 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 ▪ Limit the accumulation of leverage in financial institutions and
≥ 3% the banking sector in general;
Ratio 𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑛𝑠𝑜𝑙𝑖𝑑𝑎𝑡𝑒𝑑 𝑎𝑠𝑠𝑒𝑡𝑠
▪ Provide a "safety net" for leverage, which would complement and
strengthen capital requirements.

Liquidity coverage ratio (LCR) ensures that banks have sufficient high-quality liquid assets to survive a
short-term crisis scenario:

𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 ℎ𝑖𝑔ℎ−𝑙𝑖𝑞𝑢𝑖𝑑 𝑎𝑠𝑠𝑒𝑡

Liquidity ≥ 100%
𝑡𝑜𝑡𝑎𝑙 𝑛𝑒𝑡 𝑐𝑎𝑠ℎ 𝑜𝑢𝑡𝑓𝑙𝑜𝑤𝑠 𝑜𝑣𝑒𝑟 𝑡ℎ𝑒 𝑛𝑒𝑥𝑡 30 𝑐𝑎𝑙𝑒𝑛𝑑𝑎𝑟 𝑑𝑎𝑦𝑠
Ratio
Net Stable Funding Ratio (NSFR) focuses on the bank's ability to manage its liquidity over a period of one
year:
𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑠𝑡𝑎𝑏𝑙𝑒 𝑓𝑢𝑛𝑑𝑖𝑛𝑔
≥ 100%
𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑠𝑡𝑎𝑏𝑙𝑒 𝑓𝑢𝑛𝑑𝑖𝑛𝑔

A bank is considered to be exposed to major risks when the sum of its exposure to a counterparty, or a group
of dependent counterparties, exceeds 10% of the bank's Third Party capital 1. The measurement and control of
large exposures aims to avoid the concentration of bank exposures on a counterparty, or a group of dependent
Large counterparties, and potential bankruptcy followed by a default by the related counterparty.
exposures
ratio 𝑆𝑢𝑚 𝑜𝑓 𝑒𝑥𝑝𝑜𝑠𝑢𝑟𝑒 𝑜𝑛 𝑜𝑛𝑒 𝑐𝑜𝑢𝑛𝑡𝑒𝑟𝑝𝑎𝑟𝑡𝑦 𝑜𝑟 𝑜𝑛𝑒 𝑔𝑟𝑜𝑢𝑝 𝑜𝑓 𝑑𝑒𝑝𝑒𝑛𝑑𝑒𝑛𝑡 𝑐𝑜𝑢𝑛𝑡𝑒𝑟𝑝𝑎𝑟𝑡𝑖𝑒𝑠
≤ 25%
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑇𝑖𝑒𝑟 1
Other forms of major risk: sectoral concentration, geographic concentration, concentration of financial
resources.

PwC 25
From Basel III to Basel IV

Leverage ratio

CET
LCR

AT1
NSFR
Tier 2
>8% + capital buffer

Credit Operational
Market risk
risk risk Other topics
(IRRBB, Step-In, LE….)

A
BI ST
SA IRB SA IMA M
A A
A BCBS Documents

Invest-
Securiti-
SA IRBA SA-CCR ment- CVA Floors FRTB OpRisk
sation
funds

PwC 26
Status of Basel IV implementation in the EU

BCBS 424 („Basel IV“)

Invest- Step-
SA- Securi- Op- Leve-
SA IRBA ment CVA Floor FRTB in IRRBB P III NSFR
CCR tisation Risk rage
Fonds Risk

LE TLAC

EU Commission: CRR II-E and CRD V-E, draft issued on November 23rd 2016
Regulation (EU) Nr. 2017/2401 as of December 12th 2017

PwC 27
Timetable for the implementation

2018 2019 2020 2021 2022 2023 2024

Securitisations

SA-CCR
Investment
Fonds
FRTB
CRR II + CRD V

NSFR

Leverage Ratio G-SII Buffer

Large exp.
IRRBB

Step-in Risk

TLAC
Disclosure

Floor Regelung Transition until 2027

?
KSA
Basel IV

IRBA

CVA

OpRisk

28
PwC
Pillar 1 risks

PwC 29
Market risk

Market risk

PwC 30
Cadre actuel pour la charge en capital au titre du risque de marché
Le cadre actuel pour la charge en capital au titre du risque de marché a été introduit par l’accord de Bâle 2 en 2004, s’est vu renforcé en
2009 par la mise en œuvre de l’accord de Bâle 2.5.
Ce cadre permet aux établissements de calculer leur charge en capital au titre du risque de marché en méthode standard définie dans la CRR
575/2013 ou en approche modèle interne (IMA).

Différentes composantes à inclure dans la charge en capital au Charge en capital au titre du risque de
titre du risque de marché lors de l’utilisation du modèle interne marché en modèle interne

une perte potentielle sur la valeur d’un actif ou d’un portefeuille

Capital en 𝑚 60
VaR 99% d’actifs financiers au niveau de confiance de 99% sur 1 jour basée sur (3 + 𝛼) 10 ∗ max 𝑉𝑎𝑅𝑡−1 , σ 𝑉𝑎𝑅𝑡−𝑖−1 3
VaR 60 𝑡=𝑖
les données historiques observées ou simulées
+
12
une VaR 99% sur 1 jour calculée sur une période de stress de 12 mois Capital en 𝑚
sVaR 99%* (3 + 𝛼) 10 ∗ max 𝑠𝑉𝑎𝑅𝑡−1 , ෍ 𝑠𝑉𝑎𝑅𝑡−𝑖−1
consécutifs. sVaR 12
𝑡=𝑖
+
12
Incremental Risk Charge (IRC), la perte potentielle liée aux positions 𝑚
Capital en
IRC** susceptibles aux évènements de défaut ou de migration de notation (CDS max 𝐼𝑅𝐶𝑡−1 , ෍ 𝐼𝑅𝐶𝑡−𝑖−1
IRC 12
et obligation) sur l’horizon d’un an au niveau de confiance de 99,9%. 𝑡=𝑖

+
12
Comprehensive Risk Measurement (CRM), la perte potentielle liée aux Capital en 𝑓𝑙𝑜𝑜𝑟 𝑚 𝑓𝑙𝑜𝑜𝑟
transactions de corrélation susceptibles aux évènements de défaut ou de max 𝐶𝑅𝑀𝑡−1 , ෍ 𝐶𝑅𝑀𝑡−𝑖−1 ∗∗∗∗
CRM** CRM 12
migration de notation (CDO, FTD,…) sur l’horizon d’un an au niveau de 𝑡=𝑖
confiance de 99,9%. +
Capital
* La sVaR a été introduite par l’accord de Bâle 2.5 avec pour objectif de corriger la add-on
pro-cyclicité de la VaR. En effet, en période d'euphorie financière, la VaR diminue car
basée sur les données historiques. Ainsi, les établissement ont besoin de moins de
fonds propres, alors que lors de la détérioration de la situation, elles doivent *** 𝛼 est un facteur défini par le superviseur en fonction
augmenter leurs fonds propres pour respecter les exigences de solvabilité, avec des des résultats de backtesting de la VaR
fonds devenus plus rares et plus chers, contribuant ainsi à précipiter les banques **** 𝐶𝑅𝑀𝑡
𝑓𝑙𝑜𝑜𝑟
= max 𝐶𝑅𝑀𝑡 , 8% ∗ 𝐾𝑠𝑡𝑑𝐶𝑅𝑀 , où 𝐾𝑠𝑡𝑑𝐶𝑅𝑀 est
dans un état «d'asphyxie financière». la charge en capital pour les portefeuilles de corrélation en
** Ces deux risques, i.e. IRC et CRM, ne sont pas initialement inclus dans la VaR. méthode standard

PwC 31
Évolution réglementaire au titre du risque de marché

Bâle 1 Bâle 2 Bâle 2.5 Bâle 3 FRTB (Bâle 3.5/4)

(1988) (2004) (2009) (2010) (2020)

Aucune charge en La charge en capital au Le renforcement a été En terme de l’exigence Le framework FRTB
capital au titre du titre du risque de marché introduit avec la mise en des fonds propres au titre propose une refonte de
risque de marché n’était a été introduite, soit en œuvre de la sVaR, l’IRC et du risque de marché, mesures pour l’exigence
exigée. méthode standard soit en le CRM. aucun changement n’a été des fonds propres au titre
modèle interne en mené. du risque de marché.
utilisant la VaR 99%.

Évolution sur la méthode standard

Le cadre FRTB propose une nouvelle approche standard (SA-TB) basée sur les sensibilités, i.e. Delta, Vega et Curvature (Gamma).

Bâle3 FRTB
Évolution sur le modèle interne

VaR 99% sur un horizon de 10 jours Stressed Expected Shortfall* 97,5% sur ➢ *Stressed Expected
sVaR 99% sur un horizon de 10 jours l’horizon de liquidité allant de 10 jours à 120 Shortfall 97,5% est la
jours moyenne des pertes subies
Add-on du capital lors d’un choc qui n’apparaît
L’add-on du capital pour les facteurs de
Risk Not in VaR (RNiV) que dans les 2,5% des cas les
risque non modélisable (NMRF)
plus pessimistes sur une
période de stress. Cette
IRC 99,9% sur 1 an (défaut & migration) Default Risk Charge* 99,9% (inclut les mesure, ayant pour objectif de
positions d’action) sur l’horizon d’un an corriger les défauts de la VaR,
CRM 99,9% sur 1 an (défaut & permet de capturer le risque de
migration) La titrisation et les portefeuilles du trading de queue, i.e. les pertes extrêmes
corrélation sont entièrement inclus dans dans la queue de distribution,
La titrisation (sauf trading de corrélation) ainsi que de diminuer l’effet de
l’Approche Standard
est inclue dans la méthode standard pro-cyclicité.

➢ DRC capture les risques de défaut et de migration pour les produits vanilles de crédit (hors la titrisation
et le portefeuille de trading de corrélation) et les produits d’action.

PwC 32
Background and motivation
The new market risk requirements at a glance

Share of instruments designated to banking book over all

Material weaknesses of current approaches…
instruments (TB+BB)

60% 56% Trading book – banking book boundary

50%
40% Treatment of credit risk in the trading book
30% 22% 21%
20% 16%
10% Weaknesses of VaR approach
10%
0% Hedging and diversification
Accounting Market making Equity Listed equity Options
trading activity investment
asset/liability fund Liquidity of trading book positions

Total sample: 14 banks; BCBS QIS with reporting date 31.12.2014 and rules based on Transparency and comparability of RWA
discussion papers of Oct., 2013 and Dec., 2014 (d346, Nov. 2015)

… require fundamental review of…

1 2 3
• Banking book/trading book • New Standardised • Internal Model Method using
boundary to be more objective approach increases risk ES instead of VaR
sensitivity of RWA calculation
• Additional tools for supervision • Changes to model approval process
• Marked increase of complexity
• Floor based on standardised method

33
PwC
Revised models-Based approach
Overview

• Value at risk replaced by expected shortfall as

More of
primary risk measure
New risk measure theoretical
• 97,5% instead of 99% quantile interest

Calibration to stress • Single quantity calibrated to worst period since Difficult to get all
market condition 2005 instead of VaR and SVaR data

Different liquidity • Individual holding periods for different risk More calculation
horizons factors instead of 10 days for all effort

New DRC • Captures only default risk (no migration) Bank specific

New requirements for • Backtesting on desk level

More work to do
model approval • P&L attribution

34
PwC
Sensitivities-based Method
General structure overview

The new Standardised Approach consists of 3 components

1 Sensitivities-based method (Art. 325e – 325l CRR II) 2 3

Default risk Residual risk

Delta Risk Vega Risk Curvature Risk
charge add-on
Options only
(Art. 325w (Art. 325v
Linear risk Non-linear risk CRR II) CRR II)

• Delta: A risk measure based on sensitivities of a • A risk measure which • A risk measure that • A risk measure to
bank’s trading book to regulatory delta risk factors captures the captures the jump- capture residual
• Vega: A risk measure that is also based on sensitivities incremental risk not to-default risk in risk, meaning risk
to regulatory vega risk factors to be used as inputs captured by the delta independent capital which is not
risk of price changes in charge covered by the
the value of an option computations components 1. or 2.

• Calculation of three risk charge figures, based on three different scenarios on the specified values for the correlation parameter
(low = 0,75; medium = 1; high = 1,25)
• The bank must determine each delta and vega sensitivity based upon regulatory pre-defined shifts for the corresponding risk factors
• Two stress scenarios per risk factor have to be calculated and the worst scenario loss is aggregated in order to determine curvature risk

PwC 35
Sensitivities-based approach
Overview of the main concepts

CRR II defines the main concepts of the sensitivities-based method in Art. 325e CRR II

Risk class Buckets

1 General interest rate risk (GIRR) Means a sub-category of positions

within one risk class with a similar risk
profile to which a risk weight is
2 Credit spread risk (CSR): non-securitisation (CSR non-SEC) assigned

3 CSR: securitisation – correlation trading portfolio (CSR SEC-CTP)

Sensitivities

4 CSR: securitisation – non-correlation trading portfolio (CSR SEC-nonCTP)

5 Equity risk Means the relative change in the value

of a position, as a result of a change in
6 Commodity risk the value of one of the relevant risk
factors of the position, calculated with
the institution's pricing model
7 Foreign exchange (FX) risk

PwC 36
The Fundamental Review of the Trading Book at a
glace

“The financial crisis exposed material weaknesses in the overall

design of the framework for capitalising trading activities.”
(Basel Committee of Banking Supervision, October 2013)

Material weaknesses of current approaches… … require fundamental review

Trading book - Treatment of • Banking book/trading book boundary to

banking book credit risk in the 1. be more objective
boundary trading book • Additional tools for supervision

• New Standardised approach increases risk

Weaknesses of Hedging and
2. sensitivity of RWA calculation
VaR approach diversification
• Marked increase of complexity

Transparency • Internal Model Method using ES instead of

Liquidity of
and VaR
trading book 3.
comparability of • Changes to model approval process
positions
RWA • Floor based on standardised method

PwC 37
Revised Models-Based Approach
Overview

• Value at risk replaced by expected shortfall as

More of
primary risk measure
New risk measure theoretical
• 97,5% instead of 99% quantile interest

Calibration to stress • Single quantity calibrated to worst period since Difficult to get all
market condition 2005 instead of VaR and SVaR data

Different liquidity • Individual holding periods for different risk More calculation
horizons factors instead of 10 days for all effort

New DRC • Captures only default risk (no migration) Bank specific

New requirements for • Backtesting on desk level

More work to do
model approval • P&L attribution

PwC 38
Basic concepts
Risk measures and internal models

Risk measures
• Risk measures try to quantify possible future losses
• Risk measures should take into account both likelihood (more likely losses are worse than less
likely ones) and severity (larger losses are worse that smaller ones)
• Mathematically, future losses are modelled by random variables. They follow some
probability distribution
• Value-at-Risk and Expected shortfall are the ones most often used

Internal Models
• Internal models for market risk base the capital requirements on a risk measure to account for the
fact that two portfolios with the same notional amount can differ completely in riskiness
• Banks have certain freedoms how to calculate the risk measure but they need to fulfill certain
qualitative and quantitative criteria
• Various surcharges are prescribed by the regulator to account for risks not captured by the chosen
risk measure

PwC 39
New risk measure
Switch from Value-at-Risk to Expected Shortfall

Value-at-risk (VaR) Expected shortfall (ES)

• Does not consider tail risks and lead to unwanted • Does depend on the full distribution of tail
incentives to trading desks (i.e. taking positions losses.
where very large but unlikely losses)

Properties of VaR Properties of ES

• Definition: VaR 𝛼 (𝑋) = inf 𝑥 𝐹𝑋 𝑥 ≥ 𝛼 1 1

• Definition: ES𝛼 (𝑋) = 1−𝛼 ‫ 𝛼׬‬VaR 𝛾 (𝑋)𝑑𝛾
• The probability that the loss (modelled by random
• The average loss given that 𝑋 exceeds VaR 𝛼 (𝑋)
variable 𝑋 exceeds VaR 𝛼 (𝑋) is not larger than 1 − 𝛼
(therefore also called conditional Value-at-risk)
• Calculation for discrete 𝑋:
• Calculation for discrete 𝑋:
• Sort N losses 𝑋𝑖 in decreasing order
• Sort N losses 𝑋𝑖 in decreasing order
• VaR 𝛼 (𝑋) ≈ 𝑋 𝛼/𝑁
• VaR 𝛼 (𝑋) ≈ avg(𝑋1 , … , 𝑋 𝛼/𝑁 )

VaR suffers also from theoretical issues (it’s not a “coherent risk measure”) which are not present for ES (see appendix)

PwC 40
Classification of risk factors
Expected Shortfall only used for risk factors with good data

Risk Factor

Modellable Non-modellabe

• Need to have representative transactions in relevant • Relevant products very illiquid (less than 24
products with a history of “real” prices observations/year or gaps > 1 month)
• Capital IMMC(𝐶𝑖 ) for a single desk calculated with the • Prudent stress scenario must be used
same ES model as the trading book wide capital
• No diversification may be assumed
IMMC(C).
• Liquidity horizon must not be smaller than gaps
• Aggregated as IMMC = 0.5 IMMC C + 0.5 σ𝑖 IMMC 𝐶𝑖
between observed prices

PwC 41
Calibration to stressed market conditions
Proxy-based solution to data problem

Basel III / CRR FRTB-IMA

• Ad-hoc treatment of stressed market condition • Single calculation “calibrated to a period of
by an additional SVaR term significant financial stress”
• At least yearly updates of stressed period • Stressed period updated at least every month
• Double-counting (same scenarios in VaR and • Data since 2005 required.
SVaR) problematic

Identify Scale by
Calculate
impor- the full
stressed
tant risk current
ES
factors ES

• Reduced set of risk factors • Find the 12 month period for • Calculate ES with all risk
must explain at least 75% of which the ES calculated with factors for the current 12
P&L. the reduced set of risk factors month periods. ES𝐹,𝐶
• Full historical data (10Y) must is largest. ES𝑅,𝑆 • Combine these numbers to the
be available. regulatory expected shortfall.
• Reduced set subject to • Use the same set of risk factors
approval by regulator. with the current 12 month ES𝐹,𝐶
ES = ES𝑅,𝑆 ×
period. ES𝑅,𝐶 ES𝑅,𝐶

PwC 42
Different Liquidity Horizons
More capital requirements for illiquid positions

• In the Basel III / CRR framework, a 10- Risk factor categories (selection)
Liquidity
day VaR was used for the entire trading horizons
book portfolio. Interest rate (major ccys) 10
Holding Period in • In FRTB, there are various holding Equity vol 20
ES Calculation periods (also called “liquidity horizons”)
• Doubling the liquidity horizon increases Interest rate vol. 40
the capital requirement by roughly 40% Credit spread – high yield 60
Credit spread – structured 120

Calculation

2. Calculate
1. Calculate 4. Add the 5. Repeat from
10-day ES 3. Scale the
10-day ES scaled ES 2. with
with risk result with
with all risk (see
factors with the 𝑇-rule. 𝑛 ≥ 40, 60, 120.
factors . formula).
𝑛 ≥ 20.

2
ES = ES(𝑄)2 +෍ (ES(𝑄𝑗 ) (𝑛𝑗 − 𝑛𝑗−1 )/10
𝑗≥2
ES Q : 10-days ES with all risk factors
ES 𝑄𝑗 : 10-days ES with risk factors with liquidity horizons larger than 𝑛𝑗
𝑛𝑗 : j-th largest liquidity horizon

PwC 43
Prudent valuation

La CRR 575/2013 a mandaté l’EBA (European Banking Authority) pour définir un RTS (Regulatory Technical Standards)
s’agissant du traitement de la Prudent Valuation, ou Traitement prudentiel.
L’EBA a publié en janvier 2015 un draft final du RTS, qui a été adopté par la Commission Européenne en octobre 2016 dans
le Règlement Délégué 2016/101 complétant la CRR 575/2013 par des normes techniques de réglementation concernant
l'évaluation prudente en vertu de l'article 105, paragraphe 14.

Traitement comptable Traitement prudentiel

• La norme IFRS 13 définit la Juste Valeur comme une • Nécessité de calculer une juste valeur prudente pour les
valeur d’échange sans considération de prudence. positions du trading book et du banking book:
déduction du CET1 de AVA.

• La norme IFRS 13 permet de valoriser les • Nécessité de retenir le plus prudent du bid ou de
instruments dans la fourchette Bid /Ask. l’ask, sauf si l’on peut prouver que l’on peut sortir au
mid.

• Il n’est pas possible de prendre en compte des effets • Nécessité de calculer des ajustements pour les
de concentration pour les instruments en Level 1. positions qui sont moins liquides, notamment pour
les positions concentrées.

• Certaines composantes ne peuvent pas être prises • Prise en compte de certains ajustements :
en compte dans la juste valeur : les coûts administratifs incertitude des prix, couts de sortie, risque de modèle,
futurs, les risques opérationnels … risque opérationnel, coûts de funding, coûts
administratifs futurs.

PwC 44
Pause

PwC
Credit risk

See R.Herfray course (focus on credit risk)

PwC 46
Counterparty Credit risk

PwC 47
Counterparty Credit risk

Définition du risque de crédit de contrepartie

Définition dans le CRR 575/2013
Le risque de crédit de contrepartie ou « CCR » est le risque que la contrepartie à une opération fasse défaut avant le règlement définitif des
flux de trésorerie, liés à cette opération.

Certains exemples du risque de crédit de contrepartie

❖ Sur une opération d’achat d’une bond à règlement différé

Si la contrepartie ne
pouvait pas régler la
transaction ?

❖ Sur une transaction de dérivé

Cash Outflows payés à

la contrepartie

Cash inflows reçus Si la contrepartie ne pouvait pas

de la contrepartie régler les deux derniers flux?

PwC 48
Charge en capital au titre du risque de crédit de contrepartie et son
évolution
Mesurer la charge en capital au titre du risque de crédit de contrepartie, consite à calculer les expositions générées par les transactions dans le
future (mark-to-market dans le future ou mark-to-future).
Deux méthodes sont autorisées lors de la mesure du risque de crédit de contrepartie, i.e. méthode standardisée et internal model
method (IMM).

Dans le cadre du FRTB, la méthode standardisée est vouée à évoluer et deviendra la méthode SA-CCR (standardised approach for measuring
counterparty credit risk).

SA-CCR (Standardised approach for measuring counterparty

credit risk) 1
Standardized Method

• CEM (Current Exposure Method) EAD= alpha * (RC + PFE)

EAD* = MtM + Add-on réglementaire Où
• alpha égale 1,4 ;
• Autres méthodes proposées dans la CRR 575/2013 • RC est le coût du remplacement du moment calculé avec la méthode
réglementaire ;
• PFE est l’exposition future potentielle calculée avec la méthode
réglementaire.
Internal Model Méthod (IMM)

IMM (Internal Model Method) modélise les variations futures

de MtM * L’EAD est ensuit utilisée pour la calcul du RWA en utilisant la
méthode pour le calcul du RWA au titre du risque de crédit.
EAD* = 𝜶 Max (EEPE, sEEPE)
Où
• α est un coefficient décidé par le superviseur en fonction des
résultats de backtesting ;
• EEPE (Expected Effective Positive Exposure) et sEEPE 1 Pour plus de détails, cf. « The standardised approach for measuring
(stressed EEPE) sont respectivement les variations futures counterparty credit risk exposures » du Basel Committee on Banking
de MtM dans les environnements normal et stressé. supervision publié en mars 2014

PwC 49
SA-CCR methodology

Calculation of EAD using SA-CCR

𝐸𝐴𝐷𝑆𝐴−𝐶𝐶𝑅 = alpha x (RC + Multiplier x AddOn)

• Alpha = 1,4
Alpha • Supervisory factor
• Analogous to factor under Internal Models-based approach (IMM)

• Current replacement costs

• Calculation depends on margined / unmargined transactions
Replacement • Considering parameters of collateral agreements for margined transactions
costs
Unmargined transactions Margined transactions
RC = MAX [V – C; 0] RC = MAX [V – C; TH + MTA – NICA; 0]

• Accounts for over-collateralisation and negative mark to market values

Multiplier • Reduces add-on in these cases
PFE

𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟=𝑀𝐼𝑁{1;𝐹𝑙𝑜𝑜𝑟+(1−𝐹𝑙𝑜𝑜𝑟)×𝑒𝑥𝑝((𝑉−𝐶)/(2×(1−𝐹𝑙𝑜𝑜𝑟)×𝐴𝑑𝑑𝑂𝑛𝑎𝑔𝑔𝑟𝑒𝑔𝑎𝑡𝑒 ))}
• Potential future increase of current exposure
AddOn
• Depends on volatility of the underlying

PwC 50
The current CVA framework

Background Scope of application

• Basically all derivative transactions that are not

7

6 cleared through a QCCP

5
• But there are many exceptions according to CRR:
4
− Intragroup transactions/within a security system
Interest Rate / Spread %

US Interbank Rates − Transactions with non-financial institutions

(providing no EMIR clearing-obligation)
3 Fed Funds Rate
Spread

2
− Central and regional government (SA-RW = 0%)
1 − Central banks, BIS, MDB, ESM
0 − Pension systems
-1
− …
01.01.07 01.04.07 01.07.07 01.10.07 01.01.08 01.04.08 01.07.08 01.10.08 01.01.09 01.04.09
Time

• CVA’s are credit risk related valuation adjustments for

Approaches
derivatives (market value of counterparty credit risk)
• Before the financial crisis, counterparties had constant
• Advanced method (Advanced CVA Charge)
credit ratings. Therefore CVA’s were not relevant and
were not taken into account • Standardised method
• Because of increasing counterparty credit spreads • Alternative use of original exposure method permitted
during the crisis, institutions started to build CVA’s.
These CVA´s caused the institutions significant losses.

PwC 51
Asset Liability Management (ALM)

Asset Liability Management

(ALM)

PwC 52
Asset Liability Management (ALM)

ALM identity card

ALM : Assets and Liabilities Management

NAMES
BSM : Balance Sheet management

The ALM function is a recent function

The decree of 11/02/1993 (updated to 20/09/2010), issued by the French Ministry of the
DATE OF BIRTH Economy and Finance, relating to economic and financial terminology, sets the definition of ALM
management: "Global and coordinated method enabling a company, in particular a bank, to
manage the composition and adequacy of all its assets and liabilities and off-balance sheet items".

ALM risks arise from the coexistence within financial institutions of two spheres
(commercial and financial) that differ in terms of the characteristics of the products they
ORIGIN
deal with (maturity and terms of sale, interest rates, currency, etc.) and the teams in charge of
them.

The ALM function manages the structure of the balance sheet by identifying, measuring,
monitoring and hedging three types of risk:
• Liquidity risk: risk that the bank cannot refinance its assets due to an imbalance between
FEATURES its resources and uses
• Interest rate risk: the risk that a lasting rise or fall in interest rates (short-term and/or
long-term) will affect the bank's results.
• Currency risk: risk arising from changes in foreign exchange rates.

PwC 53
Asset Liability Management (ALM)

Transformation
The bank's core business

A bank is engaged in a variety of activities:

• Retail Banking
• Investment Banking
• Insurance
• …
But the core business of a generalist banking institution remains the transformation activity, which can be defined as follows:

Collection of liabilities with short maturities

(e.g. collection of customer deposits) in order to
Assets
issue assets with long maturities (e.g. real 10 years
estate loans). Liabilities 3 years

Source of ALM risks

The transformation activity involves a mismatch between the maturity of liabilities (short) and assets (long).
Classically, it generates a margin known as the transformation margin because liabilities with short maturities are less
expensive than those with longer maturities and long assets are more remunerative than short ones.
This maturity mismatch is also 1) a vector of liquidity risk defined, synthetically, as the risk that a Bank will no longer be able to
meet its commitments at time t, and 2) a vector of overall interest rate risk defined as the risk of a decline in the transformation
margin as a result of interest rate movements.

PwC 54
Asset Liability Management (ALM)

Liquidity gap
Benchmark for ALM management

The gap is a snapshot of the balance sheet that has been cleared by offsetting assets and liabilities.
It forms the basis for all ALM indicators.
The gap is the result, by time band, of the difference between the stocks of assets and the stocks of
liabilities.

+ 80 + 80
Assets Gap

2 years 10 years 2 years 10 years

Liabilities

- 80 - 80

Gap = Assets (+) – Liabilities (-)

Positive or negative gap

• A positive deadlock means that there is a higher proportion of assets. This is referred to as a surplus of jobs or
a transformative position.
• On the contrary, if it is negative, it means that there is a higher proportion of liabilities. It will then be defined
as surplus resources or in a position of de-transformation.

PwC 55
Asset Liability Management (ALM)

Illustration: Liquidity gap (1/3)

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
ASSETS 370,0 351,2 310,5 287,7 262,6 235,1 204,8 171,42 134,7 94,4 50,0
Notes 20,0 20,0 - - - - - - - - -
Fixed Rate Credit 200,0 187,5 173,6 158,5 141,8 123,4 103,2 80,9 56,5 29,6 0,0
Floating Rate Credit 100,0 93,7 86,8 79,2 70,9 61,7 51,6 40,5 28,2 14,8 0,0
Fixed assets 50,0 50,0 50,0 50,0 50,0 50,0 50,0 50,0 50,0 50,0 50,0
Liabilities 370,0 342,5 164,4 156,3 148,1 140,0 131,9 123,7 115,6 107,5 100,0
Deposits 100,0 72,5 64,4 56,3 48,1 40,0 31,9 23,7 15,6 7,5 0,0
Interbank 170,0 170,0 - - - - - - - - -
Equity 100,0 100,0 100,0 100,0 100,0 100,0 100,0 100,0 100,0 100,0 100,0
Off BS - - 100,0 83,6 65,6 45,8 24,0 0,0 0,0 0,0 0,0
Commitments given - - 100,0 83,6 65,6 45,8 24,0 0,0 0,0 0,0 0,0

Liquidity Gap - 8,6 246,1 215,0 180,1 140,9 96,9 47,7 19,1 - 13,1 - 50,0

450 450
400
Assets Commitments given
Liabilities
Fixed Assets 400
350 Fixed Rate Crédits 350 Equity
300 Floating Rate Credits 300 Interbank
250 Notes Deposits
250
200 200
150 150
100 100
50 50
0 0

PwC 56
Asset Liability Management (ALM)

Illustration: Liquidity gap (2/3)

500 Assets
Liabilities
400 Liquidity gap = A-L
300

200

100

0
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
-100

-200

-300

-400

-500

Conclusion : The liquidity gap is in excess of assets from 2011 onwards. These excess assets will have to be
financed by new resources obtained on the markets or from customers.

PwC 57
Asset Liability Management (ALM)

Illustration: Liquidity gap (3/3)

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 If we wish to protect ourselves
Gap (before) - 8,6 246,1 215,0 180,1 140,9 96,9 47,7 19,1 - 13,1 - 50,0 against the risk of not finding
resources in 2011, we are setting
Liabilities - - 200,0 200,0 150,0 100,0 50,0 - - - -
Credit 1 50,0 50,0 50,0 50,0 50,0 up the following 4 interbank loans
Credit 2 50,0 50,0 50,0 50,0 at TV:
Credit 3 50,0 50,0 50,0
Credit 4 50,0 50,0
• Floating rate loan of €50
Credit 5
million starting in 2011 and
Gap (after) - 8,6 46,1 15,0 30,1 40,9 46,9 47,7 19,1 - 13,1 - 50,0 maturing in 2016
• Floating rate loan of €50
Assets million, starting in 2011 and
500 Liabilities maturing in 2015
400 Old gap
New gap • Floating rate loan of €50
300 Old liabilities million starting in 2011 and
200 maturing in 2014
100 • Floating rate loan of €50
0
million starting in 2011 and
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 maturing in 2013
-100
2019
-200

-300

-400

-500

PwC 58
Asset Liability Management (ALM)

Definition of overall interest rate risk

Aggregate interest rate risk is the risk that the Company's results will be adversely affected by movements
in interest rates.

Source of overall interest rate risk

+ 80
• the volumes of assets or liabilities with the same interest rate Assets E3M
indexation are not the same

- 40 Liabilities E3M

• assets and liabilities are not indexed to the same rates, + 40

Assets E6M
• asset and liability rates are not correlated in the same way with
market rates Liabilities E3M
- 40

Interest rate risk manifests itself in different forms :

Risk of yield curve
Refixing risk Basis risk Option risk
distortion
Time difference between refixing Spread risk between two Hidden" option in a product, e.g. Not only the level of interest
or maturity dates between an normally correlated indices, e.g. the prepayment option in some rates plays a role, but also the
asset and a liability. a 3-month Libor-linked loan customer credits, i.e. the shape of the yield curve, e.g.
refinanced by a 6-month Libor- customer has the opportunity to rotation, flattening,
linked deposit. prepay his credit without pentification, etc.
penalty.

PwC 59
Asset Liability Management (ALM)

Overall interest rate risk measurement tool

Definition of Rate Gap

• The future horizon is divided into time bands ("timebucket"), generally of increasing granularity, for example: 1 week, monthly
the first 6 months, quarterly the first 2 years, annually the first 5 years, etc.
• For fixed-rate positions, the maturity of the rates corresponds to the expected maturity of the flows.
• For adjustable positions, the interest rate gap expresses the due date of the fixed rates, i.e. the date of the next
adjustment of the remaining flows on the balance sheet.
• The interest rate gap therefore makes it possible to visualise the time bands over which the margin is secured, and the residual
exposure to rate increases/decreases over each period.
• It is a measure of the impact of interest rate risk on the margin.

Interest rate and liquidity risks can be measured by a gap but are calculated differently. The major
difference is in the scope of calculation.

Liquidity Gap Rate Gap

Difference on each maturity between the amounts of Difference on each maturity between outstanding assets
outstanding assets and liabilities and outstanding amounts for which the rate is known

Two metrics that become fundamental

NII Change in the net interest margin according to different rate scenarios (x bps parallel decrease/increase,
Sensitivity flattening/pentification...)

Value Change in the economic value of the balance sheet (net present value of cash flows) according to different rate scenarios. In
Sensitivity contrast to NPV, EVE excludes non-interest-bearing items (in particular equity and fixed assets)

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Asset Liability Management (ALM)

Illustration: interest rate gap vs. liquidity gap

The product represented is a bullet loan, with a notional amount of €100 million, with a 3-year maturity and a
revisable rate indexed on the 1-year Euribor.
Which graph represents the interest rate gap? And the liquidity gap?

Chart A Chart B
100M€ 100M€
Loan Loan
0 0
1 year 2 years 3 years 1 year 2 years 3 years

Chart C Chart D
100M€ 100M€
Loan
Loan
0 0
1 year 2 3 1 year 2 3
years years years years

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Operational risk

Operational risk

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Operational risk

Current regulatory models in place for the quantification of OpRisk

“Operational risk is defined as the risk of loss resulting from inadequate or failed internal
processes, people and systems or from external events.”
Existing Models Basel Committee for Banking Supervision (“BCBS”)

Basic Indicator Approach (“BIA”)

1 15% (alpha) of the average over the previous three years of positive annual gross income

Standardised Approach (“TSA”)/Alternative SA (“ASA”)

2 Use of beta factor across 8 business lines over the previous three years of annual gross income

Advanced Measurement Approach (“AMA”)

3 Bank’s internal operational risk measurement system

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Operational risk

The standardised approach

BCBS proposes in their paper the Standardised Approach (“SA”) to address some of the shortcomings
and actually removing the options for the bank, which approach to apply for the OpRisk capital charge
computation.

Simple and
Risk Sensitive SA
Comparable

A simple financial statement Bank’s specific internal loss A sufficiently risk sensitive
proxy of operational risk data measure of operational risk.

This combination is expected to meet its objectives of promoting comparability of risk based
capital measures while reducing model complexity.

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SA components

• A simple financial statement proxy of OpRisk

• Does not penalise certain business models Business
(e.g. products bought from 3rd parties & those Indicator
based on high interest margins) (“BI”)
• Stable and comparable across banks.

• A historical loss experience risk indicator

SA
• Provides incentives for banks to improve Bank Specific
OpRisk management Operational
• Banks with low operational risk losses will be Loss Data
required to hold a lower OpRisk capital charge.

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Calculation of SA

Bringing it all together

Calculation of Business Indicator and BI Component

Business Indicator (BI) =

Interest Lease and Dividend Component +
Service Component + Financial Component

For banks in the first bucket (i.e. with a BI less than or equal to €1bn) the BIC is equal to BI x 12%. The marginal increase in the BIC resulting from a one unit
increase in the BI is 12% in bucket 1, 15% in bucket 2 and 18% in bucket 3.
For example, given a BI = €35bn, the BIC = (1 x 12%) + (30-1) x 15% + (35-30) x 18% = €5.37bn.

Calculation of Loss Component and Internal Loss Multiplier

Loss Component =
15 * Average Total Annual Loss

Calculation of minimum
ORC = BIC x ILM
operational risk capital (ORC)

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Contact

Your contact Risk & Value Measurement Service (RVMS)

PricewaterhouseCoopers PricewaterhouseCoopers
Advisory Advisory
63, rue de Villiers 63, rue de Villiers
92208 Neuilly-sur-Seine Cedex 92208 Neuilly-sur-Seine Cedex
www.pwc.fr www.pwc.fr
[email protected] [email protected]

Guillaume KALAYDJIAN Guillaume RABINEAU

Senior Manager Senior Associate

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