Transcript Economic Sanctions - INDIAN BANKS' ASSOCIATION

Market Risk
A Primer
Presentation by
T S Chandra Sekaran,
(B Sc, MA, LLB, CAIIB, CIA, CISA, CISM, CISSP, CBA, CIDA, AIQA)
Head of Securities Operations,
ABN AMRO Bank,
Dubai, U. A. E.
Member and Certified Associate, Indian Institute of Bankers, India
Member, Institute of Internal Auditors, USA
Member, Information Systems Audit & Control Association, USA
Member, ISC2, USA
Member, American Institute of Certified Public Accountants, USA
Associate, Chartered Quality Institute, UK
Member, Association of Anti-Money Laundering Specialists, USA
Market Risk
Presentation Guidelines
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No Brand or Product Promotion
No Bank Specific Questions
A Generic Presentation on the subject
The views expressed here are my own and does
not represent those of my employers, past or
present, or any of the professional organizations I
am associated with.
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Market Risk
Contents
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Introduction
Basel Committee Guidelines
RBI Guidelines/ Regulations
Risk Measurement and Management
Conclusion
References
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Market Risk
Introduction
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Market Risk
Types of Risks
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Business Risks
Credit Risks
Settlement Risk
Market Risk
Position Risk
Sovereign (Country) Risk
Concentration (Industry) Risk
Operational Risk,
Regulatory/ Compliance Risk
Reputational Risk, ……..
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Market Risk
What is Market Risk?
• Risk associated with a change in the position
value relative to market movements
• Factors:
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Interest rates
Forex rates
Equity Prices
Spread Over Swap rates
Spot Prices
Volatilities (Interest/ Forex/ Equity Rates/ Prices)
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Market Risk
Basel Committee Guidelines
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Market Risk
From Basel
• Market risk is defined as the risk of losses in onbalance sheet and off-balance sheet positions
arising from movements in market prices.
• Market risk positions subject to capital charge:
– Interest rate related instruments and equities
in the trading book
– Foreign exchange risk (including open
positions in precious metals) throughout the
bank, both banking and trading books.
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Market Risk
Capital Requirement
• Additional Risk weight of 2.5% on the entire
investment portfolio
• A risk weight of 100% on open positions in
FX and Gold
• Build up an Investment Fluctuation reserve
of upto a minimum of 5% of the investments
held in Held-for-Trading and Available-forSale categories in the investment portfolio
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Market Risk
Methodologies for computation of Capital
charge
• Standardized approach
• Internal risk management based models
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Market Risk
RBI Regulations/ Guidelines
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Market Risk
• An effective framework comprising of1
– Risk Identification
– Setting up limits and triggers
– Risk Monitoring
– Models of analysis (to measure risk)
– Risk Control,
– Risk reporting,
– Organizational set-up…
1- Guidance Note on Market Risk Management issued by RBI on October 12, 2002
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Market Risk
Interim Measures adopted in India
(For Market risks based on Basel Guidelines)
• Broad Brush and simplistic – “Standardized”
• Explicit capital for market risks
• Includes securities included in Held-for-Trading
and Available-for-Sale categories, open gold,
open forex positions, trading positions in
derivatives and derivatives entered for hedging
trading book exposures
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Market Risk
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Scope and Coverage of Capital Charge2
Manage market risks on an ongoing basis
Capital requirements maintained on a continuous
basis, at the close of business each day
Maintain strict risk management systems to monitor
and control intra-day exposures
To start with adopt Standardized approach
Specific risk charge for each security3 and General
Market risk charge towards interest rate risk in the
portfolio.
2 – Ref: DBOD No. BP.BC.13/21.01.002/2006-07 issued on July 01, 2006.
3 – Short positions not allowed in India, except in derivatives, hence includes only long positions.
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Market Risk Management
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Market Risk
Market Risk Management
• Involves measurement and monitoring of various
risk factors and establishing limits to exposures.
• Measurement:
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Non Statistical
Value at Risk (VaR)
Stress Testing
Back Testing
• Management
– Governance Framework
– Process
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Market Risk
Non-Statistical
• Notional
– Net open position, Interest Rate Gaps, ….
• Market/ Present value
– Stop Loss
• Sensitivity Measures
– Changes in market variables
– 1st Derivatives – Delta, Vega, ….
– 2nd Derivative – Gamma, …
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Market Risk
Statistical
• Value at Risk (VaR)
– Worst expected loss over a given time horizon
– Normal market conditions
– Specified level of confidence (99%, 95%, ….)
• Example:
– Assuming a confidence level of 99% and a 1-day
horizon, a VaR of $1 million means that under
normal market conditions, there is a 1 in 100
chance of a loss greater than $ 1million.
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Market Risk
VaR Methodologies
• Historical
– Simulation of historical price changes over the specified
historical window
• Monte Carlo (also called ‘Model Building’)
– Simulation based on assumed price changes under
randomly generated market scenarios, calibrated to
historical changes of market variables
• Variance-Covariance
– Based on standard deviation, assuming normal distribution
for the return of the underlying asset.
– Volatility and Correlation are the main factors used.
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Market Risk
Relative Advantages
• VaR Measures
• Identify overall exposure at the portfolio level
• Account for historical experiences
• Facilitate determination of loss appetite
• Non-Statistical Measures
• Identify exposures to individual market
variables/sectors
• Identify funding liquidity risk
• Identify settlement and rate reset risks
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Market Risk
Limitations
• VaR Measures
• Not forward looking
• Not position specific
• Computationally intensive
• Non-Statistical Measures
• Do not reflect exposure at the portfolio level
• Do not reflect statistical loss threshold if history is
to repeat itself
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Market Risk
Stress Testing
• Involves estimating portfolio performance
under most extreme market conditions, both
historical and hypothetical
– Examples:
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1987 Market crash
1994 Mexico Peso Crisis
1997 Asian Stock Market Crisis
1995 Kobe earthquake
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Back Testing
• Involves estimating how well the VaR
would have performed in the past.
• Basically evaluates the validity of the
VaR prediction model
• Compares the P&L with VaR
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Market Risk
Risk Management
• Framework
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Policies
Oversight
MIS
Control, …
• Key Processes
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Limits
Monitoring
Reporting
Resolution, …
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Conclusion
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Case Studies
Metallgesellschaft (1993)
Proctor & Gamble (1994)
Orange County (1994)
Barrings Bank (1995)
LTCM (1998)
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Market Risk
Recap…….
• Policies and Procedures
• Sound Controls and Oversight Procedures
• Accurate Risk measurement methodologies/
systems
• Adequately trained staff and functions
• Reliable technology and validated models
• In sum, (PSP)2
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Market Risk
References
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John C Hull, Options, futures and Derivatives, 2003, Pearson education
Reserve Bank of India, Guidance Note on Market risk Management, October 12, 2002
CIDA Review Manual, Investment training and Consulting Institute, KS, USA
DBOD No. BP.BC.13/21.01.002/2006-07 issued by Reserve Bank of India on July 01, 2006
RBI Notification on :Risk Management Systems in India”, dated October 21, 1999
http://www.garp.com/library/Articles/pub29.htm, Lang Gibson, Applying Proactive
Market Risk Management
Speeches delivered by:
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Dr. Y V Reddy, Sep 22, 2001 at the Seminar on The future of Government Securities Market in
India, held at Bangalore
Shri Vepa Kesam, August 30, 2002, national seminar on Banking Reforms and Strategies, held at
Hyderabad
Dr. Rakesh Mohan, December 29, 2002 at the Bank Economist’ Conference, held at Bangalore
Shri. V. Leeladhar, March 11, 2005 at the Bankers Club, Mangalore
Shri. V. Leeladhar, November 14, 2005 at the Third Natarajan Memorial lecture, at Chennai
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Market Risk
Questions
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