Basel III, Risk Assessment and Stress Testing

Basel Treatment of Market Risk

• Value at Risk (VaR) – rationale, theory and methods of calculation
• Limitations of parametric VaR
• What about tail risk – does VaR capture this adequately?
• Risk weightings for market risk
• Standardized approach
• Interest rate risk in both the trading book and banking book
• Overview of Internal Models Approach (IMA)
• Impact of market risk on instruments in the trading book
• Volatility and market stress
• Incremental Risk Charge
• Off-Balance Sheet items

Operational Risk under Basel

• Definition of Operational Risk introduced into the Basel II framework
• The life cycle of Operational Risk
• Basel measurement approaches:
  • - Basic Indicator
  • - Standard Approach
  • - Advanced Measurement Approaches
• Risk weightings under each approach
• Rogue trading – the severity of losses
• Scenario generation – KRI’s, management involvement in adverse scenario modeling
• Quantifying the exposure and severity of “outliers” and tail risk
• Loss Distribution Approach (LDA) and Scenario Based Analysis (SBA)
• Application of VaR techniques to operational risk (Op VaR)
• Loss identification – measurement, management, monitoring, reporting
• Integrating operational risk management into the organizational risk management framework

Alternatives to using external credit ratings

• Developing internal scoring models for assessing corporate loan exposures
• The contrast of developed and emerging economy approaches to credit risk assessment

Credit Concentration Risk and Large Exposures

• Concentration risk – not adequately captured under the Pillar One approaches
• A brief summary of the Supervisory Review and Evaluation Process (SREP)
• Treatment of Concentration Risk within the Pillar II ICAAP framework
• Identifying sectoral concentration risk – general principles
• Quantifying concentration risk in GCC

Modelling and Stress Testing

• Explanation of the techniques for conducting stress tests
• Backtesting using historical returns
• Scenario generation – stress testing using hypothetical returns
• Sizes of historical samples – are they sufficiently large to include a wide variety of conditions?
• The danger of optimizing risk management parameters – over-fitting to the historical data
• Modeling methods – contingency scenarios
• Limitations of the normal distribution as the basis for probabilistic modeling

Drivers of Counter-party Risk (CCR)

• Separating market risk impact on trading positions from CCR
• Pricing counterparty risk – use of spreads, ratings
• Probability of Default (PD) – estimation of PD and Exposure at Default (EAD)
• Expected positive exposure (EPE)
• Loss Given Default (LGD) and recovery rates
• Counterparty risk in credit default swaps
• Counterparty risk in interest rate swaps
• Experience of AIG and mono-lines insurance companies in financial crisis
• The role of a central clearing house
• Stress analysis and randomized stress scenarios
• Market factors which drive counter-party credit deterioration

Credit Value Adjustment (CVA) and collateral

• Definition Credit value adjustment (CVA)
• Defining credit exposure in relation to market risk impact on derivatives
• Expected positive exposure and worst-case exposure
• Nature of collateralization – ISDA treatment
• Benefits of effective collateral management
• Impact of netting on CVA
• Impact of collateral on CVA
• Hedging and credit default swaps
• Eligible hedging instruments
• Bilateral counterparty risk and collateral
• Over-collateralized positions and risk of counterparty default

Liquidity Coverage Ratio (LCR)

• Explanation of Liquidity Coverage Ratio (LCR)
• Criteria for inclusion as High-Quality Liquid Assets (HQLA)
• Categories of HQLA – Level 1, Levels 2A and 2B
• 30 day stressed market outflows
• Runoff rates
• Net Stable Funding Ratio (NSFR)
• Explanation of available funding (ASF) versus required funding (RSF)
• Weighting factors for ASF and RSF

Impact of Basel III on the Business Model of Banking

• Impact of the Basel III LCR on balance sheet exposures to non HQLA assets
• Hoarding of Level 1 HQLA assets
• Unintended consequences for macro liquidity from Basel III regulations
• Linkage of sovereign and domestic banking credit quality
• Decreased inventories of corporate bonds being held by primary dealers
• Requirements for unrealized losses with AFS securities to be deducted from CET1
• Explanation of Contingent Capital instruments (CoCo’s)
• Role of CoCo’s as a contributor to AT1 for capital adequacy purposes
• A brief history of CoCo’s an inability to see the consequences from conversion
• Sovereign wealth fund exposure to CoCo’s – elevated liquidations of SWF assets
• Possible suspensions/reductions of coupon payments of CoCo’s
• Collateral netting across CCP’s
• Shortage of collateral – implications, the effect on the bank’s ROE
• Impact of TLAC on G-SIB banks

Implementation and Reporting Systems for Basel Compliance

• Efficacy of the monitoring and reporting mechanisms within banks and how they interface with overall risk management
• Avoiding silos
• Accounting, surveillance, IT systems and data storage back-up systems
• Monitoring of controls – quality and integrity of the procedures
• Development of contingency scenarios
• Role of the Chief Risk Officer
• Role of the Internal Auditor
• Developing dashboards for KRI’s for credit, market, and operational risk