Risk Management, PRMIA

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March 28, 2008

ICAAP Forecasting- The First Critical Step for Business Planning

More and more banking regulators are coming up with their own versions of the high level Pillar 2 guidance provided under Basel 2. APRA came up with their guidance to ADIs in end 2007, Central Bank of Bahrain issued their Pillar 2 directive in January 2008 and the Reserve Bank of India has come up with their Supervisory review process circular yeaterday. Now we have Pillar 2 guidelinesfrom different part of the world and not just Europe, the leaders of the pack.

The overarching philosophy in all these documents is the same - an effort to bridge the gap between regulatory and economic capital through a comprehensive assessment of all material risks facing the organisation and planning the capital as a cushion against unexpected risks.

As you would expect, the work on ICAAP starts early on, alongwith the preparation of the business plan at the beginning of the year. It is important for any bank to have a fully integrated capitl forecast for the financial year that on one hand looks into capital availability based on expected growth of business, profits and dividends and projection of capital requirements for the firm based on the quantification of risks on the other hand . If capital requirement is onot in sync with the capital availability, the organisation may face trouble in the capital management process.

Preparing an ICAAP forecast therefore is a forward loking process starting early on in the entire ICAAP initiative. It may not be as full blown an initiative as the ICAAP document in itself, but a first cut esimate based on several assumptions about businesss profile and estimated growth, emerging macro and micro risks, broad trends in each risks, some assumptions about their correlation structure .

An ICAAP forecast should be an information in the hands of the Board while preparing the business plan while the ICAAP will be a document which will base itself on the business plan of the firm. The two documents are complementary to each other, fulfils different objectives, differ in their degree of details and assumptions. While there is a fair degree of clarity o how an ICAAP document should be arrived at, there is a lack of clarity on ICAAP forecasting as a first step for business planning. As Banks soli their hands in ICAAP preparation, and regulators enter the field for the supervisory review, the issue of forecasting the ICAAP will inevitably come to the fore.

Posted by sunandoroy at March 28, 2008 08:31 AM