Brendan Mcinerney PDF

8/11/2019 Brendan Mcinerney PDF

1/45

Group Risk Control

CC Risikocontrolling

Credit & Counterparty Risks

RCO

Intranet-Based Distribution of Credit Risk Modeling

Technology and Ex Ante RoRACCalculations

Presentation for the Seminar on EU insolvency law Reform of the capitaladequacy DirectiveBudapest, September 26, 2002

Brendan McInerney


2/45

Dresdner Bank AG Title of presentation Date 2

Group Risk Control



RCO

Contents

Introduction

Overview of Concepts

Fundamentals of Multi-Period Calculations

ExPLORER Current Features

ExPLORER Screen Shots

Outlook


3/45


Group Risk Control



RCO

Central Role of Banks in Risk Transformation

One of the fundamental roles of banks in an economy is theassumption, monitoring and mitigation of risks.

In the current business environment of the global bankingindustry, efficiency in performing these tasks has become

a clear driver for competitive advantage.

Overriding goals of risk control and risk management:1. Measurement of risks and their drivers2. Ensure appropriate returns for the assumption of risk

3. Optimize risk-return trade-off

Ultimate Goal:Creation of Shareholder Value


4/45


Group Risk Control



RCO

Why are Credit Portfolio Models Relevant?

Banks face competition from debt capital

markets in their

traditional lending business(disintermediation)

Banks traditionally make lending (buy)

decisions on a stand-alone basis, often

employing return on regulatory capitalmetrics instead of measures based on risk

contribution

Shareholders are demanding risk

transparency

Shareholders are demanding superior

risk-adjusted returns

Banks face increasing competition from

asset managers who now offer exposure

to the same asset classes (I.e. high-yieldbonds or syndicated loans) as an

alternative to investing in bank equity

Buy-SideCompetition Sell-SideCompetition

Banks have an overriding need to identify the economic value

associated with transaction and business activities


5/45


Group Risk Control



RCO

Risk-Adjusted Return Metrics: Why Bother?

Return Metrics as an Input to the Credit Decision Process

In order to determine whether to commit to a given transaction or not, an

assessment regarding the profitability of the transaction is necessary

Need for Ordinal Ranking of Proposed Transactions Necessitates:

Definition of methodology to calculate common-sized return metric

Harmonization of input parameters

Distribution channel for transaction pricing

Organizational buy-in and consistent implementation

Potential Application of Hurdle Rate

Through the definition of a minimum return expected from individual

transactions (Hurdle Rate), the common-sized return metric can be used for

an explicit decision rule in the credit process.

Choice of Type of Capital: Return on Regulatory Capital (RoRC) vs. Return on Risk

Capital


6/45


Group Risk Control



RCO

Dresdner Banks Approach to Risk Adjusted Return Metrics

Return Metrics are calculated during the origination process and

submitted as part of the approval process

Calculation of Return Metrics is automated to ensure consitent results

Automation achieved via an Intranet-based application: ExPLORER

All calculated transactions can be saved and used as the basis for

analysis of various risk / reward measurement methodologies and for

support of marketing strategies

Best practice portfolio managementstarts at the point of origination


7/45


Group Risk Control



RCO

Credit Risk Modeling Framework

Acquisition

and Pricing of

Proposed

Transactions

Integration of all

booked deals

in reference

portfolios

Portfolio

Credit Risk

and RoRAC

Measurement

Portfolio

Risk/Return

Reporting

and Analysis

Active Portfolio

Optimization

Functions

Portfoliocreditriskprofilebyreferenceportfolioasinputforpricingofproposedtransactions

basedonamarginalriskimpact

Performancemeasurementonthebasisofimprovementsinrisk-adjustedreturnmetricsand

relativetoapplicablebenchmarks

Portfolioreportsandanalysisasinputforportfolio

optimization

Portfoliocreditrisk/returnprofileasaninputfor

portfoliooptimizationdecisions

Integrationofportfoliorisk/returnmetricsintoreportingandanalysis


8/45


Group Risk Control



RCO

Risk Quantification and Loan Pricing Infrastructure

Data Preprocessing

for Portfolio Risk/

Return Calculations

Results by

Reference Portfolio

OverallBranchA

BranchB

DivisionC

DivisionD

Etc.

Assignmentofcreditriskpara-meters(EDF,LGD,UGDetc.)ConsolidationofAccountIDtoObligors

Applicationofcurrentmarketconditions

PortfolioAnalysis

Analysisofrisk/

returncontributionbyvariousdimension

(country,industry,rating,productetc.)

IdentificationofriskconcentrationRiskAdvisorytoseniormanagementInputtoPort.Optim.

Active PortfolioManagement

Risk/Return

OptimizationExecuteTrades

PerformanceMeasurement

Buy,

hedge

Input for RoRACLoan Pricing Process

Basedonmarginal

contributiontoportfoliorisk

EconomicP&L

CreditVaR Limitmonitoring

Heterogeneous

Source Systems

SystemA

SystemB

SystemC

SystemD

SystemE

Etc.

Data Integration /

Data Warehouse

Integrationofport-foliodatafromvarioussourcesystemstoacommonplatformStandardizeddatastructures

ObligorIdentification

Sourceforinternalandexternal

Portfolio Risk/

Return Calculations

Riskcalculations

separateforeachreferenceportfolio

Stresstesting

SensitivityAnalysisMark-to-Model

valuations

Calculation ofRoRAC based on

User Inputs

Originationo

fnewl

oana

ssets

UtilizationofIntranet-basedloanpricing

tool

sell,


9/45


10/45


Group Risk Control



RCO

Credit Risk Methodology: Overview

The Drivers of the Loss Distribution of the Reference Portfolio

UL

Economic Capital (Credit VaR):

J oint Default Correlations of obligorsimpose shape (leptokurtosis, fat tail) on

the portfolio loss distribution The amountof outliers beyond a certain cut-offdetermines Credit VaR in a quantile

calculation.

Driver of the Unexpected Loss:

Full probabilistic revaluation of the assets

at the end of the time horizon yieldsunexpected loss on a stand-alone basiswhich is subsequently aggregated to

the portfolio level.

Loss Gain

Driver of the Expected Loss:

Default Probabilities of Obligors (e.g. EDF from KMV Credit Monitor; calibration of internal ratings)Loss Given Defaults (LGDs) of Exposures: Capture actual losses net of mitigating factors (e.g. collateral)Usage Given Default (UGD): Incorporate the draw-downs on open limits (e.g. Credit Lines Undrawn)Time Horizon:Time frame for which the effects of credit migration in the future is to be evaluated.


11/45


Group Risk Control



RCO

The Evaluation of Single Exposures WithinThe Context of a Portfolio of Credit-Risky Assets

CUL

RCC PP

B

B GainLoss

ULPULP

Economic Capital(Credit VaR)

Risk Contribution of

Single Exposure to the

Variance (Risk)

of the Overall Portfolio

Economic

Capital Allocatedto Single Exposure

ExposureSingletoAllocatedCapitalEconomic

)AlonedtanS(LossExpectedturnRe:RORACB

Ch i f R f P tf li Th Eff tOf Di ifi ti


12/45


Group Risk Control



RCO

Choice of Reference Portfolio: The Effect Of Diversification onMeasured Risk

Branch A

Branch B

Branch C

Branch D

RegulatoryCapital(8% ofRWA)

83%

43%

67%

30%

100%

100%

100%

100%

Compared with:

Regulatory Capital50% Reduction of

measured risk

through integratedcalculation of

branch portfolios

Sum of risk of

individual branch

portfolios (=100%)Selected Branches

at a 99,95%

Confidence Level


13/45


Group Risk Control



RCO

Transaction Pricing Based On RoRC- and RoRiskCap-Metrics

Regulatory Capital Usage 2)

Net Return after TaxesRoRC =

Net Return after Taxes

Risk Capital1)RoRiskCap =

Spread and Fee Revenues of Credit Transaction (Originating Unit Income)

- Standardized Administrative Costs

- Expected Loss due to Credit Risk (Standard Default Costs)

- Expected Loss due to Transfer Risk

- Liquidity Costs (Long Term Funding Policy)

+ Capital Benefit

- Taxes (based on location specific tax rates)

= Net Post-Tax Profit

StylizedP&LStatement

1 BasedontheGroupRiskCapitalMethodologyversion2.0whichreplacedEconomicCapitalversion1.5

2 BasedontheTargetTierICapitalRatioof7.25%ofrisk-weightedassets(BaselI)oranestimationofBaselIIAdvancedApproachcapital.


14/45


Group Risk Control



RCO

EconomicValueAdded(EVA)Transformation fromReturn on Capital Metrics

Net Return after Taxes

Risk CapitalRoRiskCap =

(Net Return after Taxes) (Risk Capital * Hurdle Rate)EVA =

After tax hurdle rate was set by Allianz Group at 9,95% for Dresdner Bank


15/45


Group Risk Control



RCO

The Impact of Applying Regulatory vs. Risk Capital to thePricing of Single Transactions

Basic Intuition: Byreplacingtheregulatorycapitalusageasthebasisforrisk-adjustedpricingbyriskcapital,yetanotherdriverofdifferentiationamongproposedtransactionsisintroduced.

Result: Ordinalrankorderofsingletransactionsandtheassociatedbanking

relationshipsmaychangedramatically,especiallytowardstransactionswithobligorsofhighcreditquality.

RegulatoryTierIandIICapitalUsageforCorporates

MeasuredCreditRisk(RiskCapital)

TargetTierICapitalRatio

RoRiskCap

>

RoRC

RoRiskCap

Documents

Brendan Mcinerney PDF