January 17, 2009
GRM- Global Risk Mgmt and Governments Risk Mgmt with a $5 trillion plus kitty
Wishing everyone a happy and safe new year!
2008 was a humbling and disruptive year for the Financial sector, specially the bulge bracket Investment Banks as well as Risk Management profession on the whole. Many epitaphs will be written for legendary institutions that disappeared overnight and will be spoken about for decades to come in terms of the crunching global impact and the associated learnings. About $650bn of sub-prime bonds outstanding in March 2008, about 75% of them being rated triple A at issuance, and banks raised around $600 billion in 2008 worldwide to survive. This blog sets the context to a global development with wider and long term implications for the Risk Management role and function of the Governments and Sovereign Wealth funds.
GRM - Global Risk Management or Governments Risk Management
With FDIC chair floating the Aggregator bank idea this morning, there is a fascinating convergence of free markets and role of Governments as Risk Managers of last resort. There is an ongoing global risk management effort that although coordinated in some parts (e.g. G7, EU) and disparate in other parts of the world, does show signs of an orchestrated and coordinated effort. The different measures listed below really being the tactical components of a broader and longer term Governments Risk Management effort to rescue firms and economies -
1.Unprecedented direct intervention by Govt. bodies and regulators like FDIC in overnight in takeover/shotgun sales of financial institutions
2.Unprecedented but time bound Governments pledge to guarantee all loans and deposits
3.Bailouts plans such as US TARP
4.Stimulus packages
5.Benchmark rates cut
6.Assumption of toxic securities
7.Equity stake and nationalization in extreme cases
8.Interbank and debt guarantees
9.Recapitalization
10.Asset Restructuring body/Aggregator bank
Today, it is very rare to hear debates on the role of direct government intervention even in the strongest bastions of free market economies. In the past it had been very subtle support and interventions by Sovereign Wealth funds (SWF), but never of the current scale.
Below is a summary of the global risk management efforts of governments of some of the major developed and emerging economies around the world.
USA - $ 850bn (6% of GDP) - $ 700bn TARP; $300bn guarantees, FedReserve rate cut to 1%, $1.3 trillion bank lending, $150bn stimulus package, ($ 500bn planned by new govt)
China - $586bn (16% of GDP) – 2 yr stimulus comprising rural infrastructure, social services, railroads, airports, health, education, housing & more
UK - $ 450bn (21% of GDP) - $311bn to exchange illiquid securities for govt. debt, $116bn to recapitalize, $389bn guaranteed new bank debt, $23bn tax breaks
Russia -$ 209bn (12% of GDP) - $ $50bn credit line for Corp debt refinance, $88bn bank loans,$19bn stock market support
Germany -$ 151b( 7% of GDP) - $101bn in new capital, $25bn bad loans cover, $504bn interbank guarantees,$25bn tax breaks
South Korea - $ 80bn (9% of GDP) - $25bn stimulus, $55bn forex loans for exporters, $100bn guarantees for banks forex liquidity
Japan - $ 68bn (1%of GDP) -2 stimulus packages incl. tax cuts, tax breaks, credit guarantees,$322bn loan guarantees for small & midsize businesses
France - $ 50bn (2% of GDP) - $13bn to recapitalize($37bn more pledged), $403bn interbank guarantees
India -$ 41b(5% of GDP) - $ $4bn loans to mutual funds, $37bn in bank loans due to reserves rate cuts
Summary: The GRM program around the world is committing to around $5 trillion plus with amounts committed being anywhere from 1% of GDP to a high of 21% of GDP in UK. Many countries GRM initiative includes nationalizing failed financial institutions as well. So the GRM is a facet of Risk Management that will remain in forefront for years to come and CRO’s
Takeaways –
1.An additional dimension for CRO to deal with, if their institution is subject to GRM activities
2.Lessons learnt from GRM will feed into a heavier touch for Regulators in industry Risk mgmt
3.The lessons learnt by governments around the world in rescuing” Too big to fail” firms will have an impact on the future viability and ambitions of the “financial supermarts” around the world.
4.This GRM effort will have far reaching impact on the Risk Management role of governments and implicitly the role of Risk Management in society.
Sources: Dow Jones Financial News, Issue 635,A year in numbers; Business Week Dec 1 2008(Peter Coy, Enough Shock treatment)
Posted by spachava at 05:26 PM
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August 24, 2008
Basel II Cross border realties - EU's CEBS releases range of practices
As the Basel II journey continues world over, the European Banking Supervisors (CEBS) recently released a range of practices on Basel II implementation issues.
I found this paper very informative and interesting and highly recommend to anyone interested in the practical realities of Basel II implementations across borders.
This compilation is based on CEBS significant involvement over last year in collecting and analyzing the Basel II implementation issues that cross-border groups and their supervisors believe to be the most challenging from a cross-border perspective.
This report classifies Basel II implementation into 3 groups and addresses some practical issues observed.
A) Supervisory process for model validation.
B) Pillar 1 technical issues
C) Pillar 2 issues
I cover off only some of the high level aspects to pique your interest to read the entire 18 page paper. The paper handles key issues in each of the above 3 areas and provides examples from specific scenarios around them.
A) Supervisory process for model validation
A key question handled is - Has delegation/division of tasks between supervisors been applied in practice? Which are the most relevant tasks to be delegated/allocated to home and host supervisors?
Summary of the observation - This is effective where the supervisors collaborate to perform the task they are best placed to conduct. The key point being that delegation needs to work both ways i.e. Host delegating to Home and Home delegating to Host. Generally speaking, home supervisors should inform hosts of centrally performed model reviews, and hosts are responsible for the supervision of local model implementation issues.
More specifically the home supervisor being responsible for the review of the internal governance of model validation (rating process, control environment, stress testing, worldwide model implementation, internal audit etc.), including the review of a sample of centrally developed models, and the examination of the adequacy of the related IT environment.
In the case of centrally developed models that are applied across the banking group (group-wide models), the home supervisor leads the approval work. Where models applied across the banking group are developed/managed/enhanced at a subsidiary banking entity, the home and host supervisors jointly carry out the approval work. Host supervisors are responsible for the assessment of specific local requirements. Host supervisors are generally responsible for the examination/assessment of the implementation of the rating systems developed by the local subsidiary.
Where a model is applied in several countries, the host supervisors of the subsidiaries where the main developmental work has been performed are responsible in consultation with the home supervisor.
- Local and central models A key question addressed was -
- How are local and central models defined? Are differences driven by specificities and/or organizational arrangements of banking groups?
Summary - Here broadly two main approaches were seen to be prevalent on the basis of the experience gained so far.
- The first one uses geographical specificities as the driver for separation and examines whether a particular rating system requires any local aspects to be taken into account. If this is the case,
the model is defined as local; if local aspects do not have a role, the model is considered to be central.
- The second approach focuses on the division of tasks within the banking group. Models developed, tested and validated by a central unit and used on a group-wide basis are defined as central models while models developed, tested and validated locally, and used in one or more entities, are considered to be local models.
The other issues handled in this section being:
- Portfolio classification - Is it possible for banks to adopt the IRB classification for exposures subject to the Standardised approach on a temporary (roll-out) and/or permanent (permanent partial use) basis?
- Use test for new models - How can the use test requirement be applied practically for new models?
- Supervisory assessment of group-wide models - What is the role of home and host supervisors in the validation of central models?
- Language of IRB/AMA application - In which language do banks have to submit the application to use internal models to the home supervisor? Is the approach consistent across banking groups?
B) Pillar 1 technical issues. In pillar 2 key topics addressed are around default defintion and downturn LGD.
- Definition of default - Which definition of default (DoD) is applied in practice across a cross-border banking group? How is the default of individual entities related to the default of groups?
Summary - Some groups use a different DoD for the consolidated calculation, whereas others use a single DoD across all the group’s entities. However, the first approach is not perceived to be a major problem.
- Downturn LGD - What are the banks’ methodologies to estimate the “downturn LGD”, as requested by the CRD? What is the supervisory approach?
Summary - Different approaches are explianed via different real life examples. Example 1 is around UK FSA. The UK Financial Services Authority has published a paper in which the results of an empirical exercise on downturn LGD estimates are presented1; data were gathered from 12 firms. The main outcome at this early stage is that the degree of variation of the two key downturn parameters (i.e. reduction in property value and probability of possession given default) is quite large. Therefore, some “reference values” for these variables are provided (-40% and 35% respectively), which could be used by each bank for discussion with supervisors. As soon as firms improve their estimation techniques, and the available data increase, FSA expects the thinking on this topic to evolve.
Example 2 is around Spain. The Bank of Spain has published a paper2 in which the requirements for downturn LGD for residential mortgages are presented. The document defines the following concepts: realised, long-run average and downturn LGD; it also requires a minimum segmentation in the estimation process based on risk drivers; and finally, it identifies the estimation procedures accepted.
Other issues covered in this section being-
- Estimation and validation of risk parameters in “low-default-portfolios” - What are the approaches followed by banks to estimate and validate risk parameters for “low default portfolios”? What is the supervisory approach?
- Project finance - What are the banks’ methodologies for estimating risk parameters for Project Finance? What is the supervisory approach?
C) Pillar 2 issues
- Scope of application of ICAAP - What is the scope of application of ICAAP?
- Requirements imposed for ICAAP - What are the requirements that banks have to follow for ICAAP?
Acknowledgment and Source: CEBS Paper on Range of Practices on some Basel II implementation issues.
Posted by spachava at 07:34 AM
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July 16, 2007
Pillar 3 Disclosure - Prudential Std APS 330 Consultation paper from APRA
As the Basel II saga continues, in some developed countries the implementation is slowly inching past the Pillar 2 Supervisory review & model validation phase towards the Pillar 3 disclosures. In Australia, APRA has released APS 330 - a draft prudential standard for Market disclosure.
Summary: Last month in June, APRA released the market draft prudential standard APS 330 Capital Adequacy: Market Disclosure (APS 330). This sets min. prudential disclosure requirements for locally incorporated ADI’s (Authorized Deposit taking Institutions) and a limited set of (quantitative only) disclosures for foreign owned subsidiaries.
During my Risk modeling days, I was lucky to have the opportunity to interact closely with the Supervision deptt. of a few Central banks that were refining their Risk Assessment and Outlier methodology in preparation for Basel II.
Since then, I have always been a keen follower of the consultation papers released regularly by Supervisors. I find the papers and the the industry responses, very insightful & useful to feel the local pulse, benchmark the Basel II progress & understand the local industry concerns. APS 330 is one such recent paper from the proactive APRA (Australian Prudential Regulation Authority) on Pillar 3.
In summary, the APS 330 std proposes that all ADI's make at least some basic level of disclosure of their capital adequacy and mandates Pillar 3 disclosure for all locally incorporated ADI's in Australia, with minimum requirements.For a locally incorporated and owned ADI’s that have adopted advanced Basel II approaches, the requirements involve full and detailed disclosure broadly consistent with the Pillar 3. For all other ADIs, including foreign-owned subsidiaries, a limited set of (quantitative only) disclosure requirements relating to capital structure, capital adequacy and credit risk exposure is proposed.
The proposed guidance strives for a balance between a pragmatic approach to the Pillar 3 disclosure requirements with due consideration to the market disclosure needs as well as to minimise the reporting burden on the smaller ADIs.
The APS 330 proposal for Prudential disclosure also includes the following specifics on the how to:
- Specific order/layout of disclosures to allow comparison across institutions
- Websites as one of the readily accessible medium/location of the disclosures
- In specific instances, provision for an ADI not to disclosure proprietary and confidential information
I also wonder if the Market Disclosure needs will also eventually trigger the industry adoption of 2 items from my list of 10 items in my blog on Risk mgmt frontier.
1.Standardization of commonly used Risk reporting termswhat I refer to as Risk Mgmt taxonomy.
2.Risk Visualization - Adoption of reports that are visually easy to read and interpret.
The other recent Basel II papers being:(my next blogs)
- APRA revised Basel II advanced approaches, June 13
- APRA revised Basel II securitisation standard July 11
Source: APRA APS 330 Capital Adequacy: Market Disclosure, June 2007
http://www.apra.gov.au/Media-Releases/2007-Media-Releases-Home.cfm
Posted by spachava at 12:47 PM
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