workshop afgap-alma professional training in alm 11 may 2012
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Workshop AFGAP-ALMA
Professional training in ALM
11 May 2012
ALM Professional training in France
As of now, only in-house ALM training programs do exist in France
For example, Société Générale and BNPP have developed their in-house programs exclusively dedicated to their own employees
As far as we are aware, there is no academic-based training specifically oriented toward asset-liability management
Nevertheless, many academic programs on asset management, risk management, mathematical finance, actuarial sciences etc. do actually exist
AFGAP has been working on a comprehensive training program in ALM under the following guidelines:
mostly oriented towards banks (versus insurance companies)
sponsored by AFGAP and its stakeholders
anchored in one (or more) academic institution, for example ENSAE which is one of the leading graduate school in economics, finance and quantitative analysis
delivering both academic and professional certification
ALM Professional training in France: An example
Level 1 (2-3 days)
• Intoduction to banking book risks
• Definition, economic and regulatory context, main challenges about Liquidity Risk
• Definition, economic and regulatory context, main challenges about Interest Rate Risk
• Definition, economic and regulatory context, main challenges about Currency Risk
• Organisation, gouvernance and risk policies
Level 2 (2-3 days)
• Focus on balance-sheet / off balance sheet main exposures
• Modeling of maturing / non maturing products
• Liquidity gap, interest rate gap, risk measurement
• Main risk indicators: gaps, duration analysis, interest rate margin sensitivity, present value, Earnings-at-Risk
• Static liquidity gap and on-going concern gaps
• Hedging and Funding Transfer Prices
• Regulatory context: ratios, accountancy rand prudential requirements
Level 3 (2-3 days)
• Option modelling in ALM: interest-rate-capped loans, fixed/variable rate loans, early repayment/termination etc.
• Off-balance sheet and non-plain vanilla hedging products: swaptions
• Non-linear risk modeling
• Advanced hedging
• Economic capital and capital management
ALM Professional training in France: An example
Employees targeted :
• ALCO members
• ALM employees in F/O and B/O departments
• Risk managers
• Internal auditors / Accountants
• Quants
• Budgeting and Capital planning executives
• All employees in Finance divisions, Retail and Corporate management units etc.
ALM Professional training in France: AFGAP objectives
AFGAP Objectives Extending in-house program to set up a 80-hour program aimed at training any employee from AFGAP stakeholders
Providing trainees with a common and unified package of skills and core competences
Enhancing ALM culture in France to strengthen banks position when discussing with French and foreign regulators
Developing an international english-based training program in the coming years
Enrolling supervisory bodies’ and regulators’ employees in the program
Connecting ALM with academic curriculum in order to develop academic research in this field
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Example of a training program - 4 modules
1. Fundamentals of structural risks management E-learning of 80 slides.
2. Level 1 - Introduction to structural risks management 2-day training in a classroom with exercices
3. Level 2 – Advanced practice for the management of structural risks 2-day training in a classroom with exercices and a case study
4. Level 3 – Management of implicit and explicit options in ALM 2-day training in a classroom with exercices
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I. Fundamentals of structural risks management
• Introduction.• The yield curve.• Intermediation activity and the ALM perimeter.• The schedule and gap principles.• Liquidity, interest rate and foreign exchange risks.• Fund transfer pricing.• ALM function regulation and organization.
Summary
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2011 2012 2013 2014 2015 2016 2017 2018
II. Level 1 - Introduction to structural risks management
• Introduction to structural risks and their management– Banking intermediation– The bank balance sheet– Origins and impact of structural risks– Principles and tools for structural risks management
• Liquidity risk and its management– Origins and impact of liquidity risk– Liquidity spread– Illustration: the 2007-2008 and 2009-2011 financial crises– Measuring liquidity risk: indicators– Managing liquidity risk– Regulatory guidelines regarding liquidity risk
Summary – 1st Part
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2011 2012 2013 2014 2015 2016 2017 2018
• Interest rate risk and its management– Origins and impact of interest rate risk– Interest rate risk illustrations– First interest rate risk measurement: the interest rate gap– Building the interest rate gap: illustrations– Second interest rate risk measurement: sensitivity.– Managing interest rate risk– Fund transfer pricing– Regulatory guidelines regarding interest rate risk
• Currency risk and its management– Origins and impact of currency risk– Scope and measurement of currency risk– Managing currency risk
• How risk management is organised in a bank– Regulatory guidelines and their transposition to banks– The role of ALM within a bank– The parties involved in risk management
Summary – 2nd Part
II. Level 1 - Introduction to structural risks management
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2011 2012 2013 2014 2015 2016 2017
III. Level 2 - Advanced practice for the management of structural risks
• Reminders about the basics – Reminders on structural risk– Reminders about the yield curve
• Scheduling of balance sheet items– Contract Maturities and modeling principle– Prepayments– Non scheduled deposits and modeling principles– Off Balance sheet commitments– Reserve requirements– Overdrafts
Summary – 1st Part
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2011 2012 2013 2014 2015 2016 2017 2018
• Indicators and hedging of structural risks– Interest rate risk– Liquidity risk– Fund Transfer Price
• External Regulation
• Special Cases: the shareholders' equity in the management of structural risks – Definitions – Group Principles on the reinvestment (re-investment) of Shareholders’ Equity
Case study: preparing and conducting of the ALM Committee
Summary – 2nd Part
III. Level 2 - Advanced practice for the management of structural risks
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2011 2012 2013 2014 2015 2016 2017 2018
IV. Level 3 - Management of implicit and explicit options in ALM
• Part 1 - Modeling prepayments• Part 2 - Modeling of home-buyer's savings plan • Part 3 - Review of the notions of convexity, duration and sensitivity• Part 4 - Pricing of a cap• Part 5 - Calculation of optional ITR• Part 6 - Value at Risk
• Part 7 - Economic Capital required for the interest rate risk
Summary
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Illustrations
deposits
Banking intermediation
• The fundamental role of a commercial bank is to:– Raise funds from its customers (resources);– Grant loans to various customers (uses).– Examples:
• This is a bank's intermediation role.
14
salaries
loans
The bank balance sheet
15
ASSETS LIABILITIES
CUSTOMERUSES
MARKETS
FINANCING
FIXED ASSETS
CUSTOMERRESOURCES
SHORT-TERMFINANCING
LONG-TERMFINANCING
SHAREHOLDERS’ EQUITY
COMMITMENTSGIVEN
MARKET TRANSACTIONS
COMMITMENTS RECEIVED
MARKET TRANSACTIONS
Off-Balance sheet
Balance sheet
ALM Department
Principles and tools for risk management
• In order to guarantee that the Commercial Department receives its due share of the margin, the bank has set up the ALM Department, which matches every customer loan and every customer deposit at the market rate by going through the bank’s Treasury.
4.5% over 5 years
3% over 3 months5% over 5 years
3% over 3 months
4.5% over 5 years
2% over 3 months
16
17
Principles and tools for risk management
• Transformation and anti-transformation– Two words with opposite meanings:
• Transformation: short-term resources of funding matched by long-term uses• Anti-transformation: means borrowing long to lend short• The transformation margin: is the gain realised on the difference between short and
long-term rates.
2,5
3
3,5
4
4,5
5
0 1A 2A 3A 4A 5A 6A 7A 8A 9A 10A 11A 12A 13A 14A 15A 16A 17A 18A 19A 20A3
3,1
3,2
3,3
3,4
3,5
3,6
3,7
3,8
3,9
0 1A 2A 3A 4A 5A 6A 7A 8A 9A 10A 11A 12A 13A 14A 15A 16A 17A 18A 19A 20A
Transformation: margin if the curve is positive
Anti-transformation: margin if the slope is negative
Interest rate risk hedging
• Example 1: Hedging by term borrowings starting spot (if there is no swap market )
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Limit = 1 A0 A1 A2 A3 A4 A5 A6 A7 A8 A9 A10
Interest Rate Gap - 73 - 67 - 56 - 45 - 45 - 28 - 7 - 19 33 - -
Sensitivity before hedging = -2.7FR Interbank borrowing 100 100 100 FR Interbank borrowingFR Interbank borrowing
Interest Rate Gap after hedging - 27 33 56 - 45 - 45 - 28 - 7 - 19 33 - -
Sensitivity after hedging = 0
A1 1,0A2 1,9A3 2,7A4 3,5A5 4,3A6 5,1A7 5,8A8 6,5A9 7,1A10 7,7
Sensitivity of an operationof notional 100 and of maturity :
-80
-60
-40
-20
-
20
40
A0 A1 A2 A3 A4 A5 A6 A7 A8 A9 A10
Interest Rate Gap
Interest Rate Gap after hedgingPassifs
Actifs
Building the liquidity gap: illustrations
• Example: Fixed term loan falling due in 10 years (a kind of repayment loan with constant payment intervals).
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Constant payment amortisation profile
Y0 Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10
Liquidity riskBuilding the liquidity gap: illustrations
• Example: building a liquidity gap - Assets
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Assets
0
50
100
150
200
250
300
350
400
450
A0 A1 A2 A3 A4 A5 A6 A7 A8 A9A10
Commitments givenFixed assetsIndexed rate loansFR loansSecurities
0,00%
1,00%
2,00%
3,00%
4,00%
5,00%
6,00%
janv.-
03
sept.
-03
mai-04
janv.-
05
sept.
-05
juin-
06
févr.-
07
oct.-0
7
juin-
08
mars-09
nov.-
09
juil.-1
0
mars-11
nov.-
11
3M 12M 5Y 10Y
Origins and impact of interest rate risk
Inversion of the yield curve
21
Market rate volatility.
Steepening of the yield curve
Flattening of the yield curve
22
Internal transfer rate
• Principle of notional backing within ALM
– Example with a loan customer.
– Example with a client term deposit.
ALM Branch ClientVirtual Loan
same characteristics as the loan customer
Loan to the client
ALM Branch ClientVirtual Placement
same characteristics as the customer deposit
Customer deposit
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Internal transfer rate
• The internal transfer rate (ITR) intervenes in the interest margin breakdown : – Example for a loan that the Branch performs with his client:
Markets Branch ClientTreasury ALM
CUSTOMER RATE
ITR ALMREFUNDING
RATE
MARKETSREFUNDING
RATE
Net interest income credit
Cash marginALM margin
InteresGross Margin
t
Margin = Sales + structure + costs + Credit costs Cost of
Equity ...
Internal transfer rate
• Example 1: Indexed rate loan
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Customer rate 3M EURIBOR + Margin : 3.5%
3M EURIBOR: 2%
Liquidity: 0.4%
Commercial margin: 1.1%
FTP 2.4%
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Internal transfer rate • Example of calculation for a profile depreciable/amortizing profile? (non-linear).
Width W (years) 1 2 3 4 5
1 year 2 years 3 years 4 years 5 years Period
amount
75
ITR 2 years = 3.55%
ITR 1 year = 2.5%
ITR 3 years = 4.15%
ITR 4 years = 4.75%
ITR 5 years= 5%
Height H (amount) 17.2 16.1 14.9 13.9 12.9
Area = W H 17.2 32.2 44.7 55.6 64.5
ITR 2.5% 3.55% 4.15% 4.75% 5%
ITR Area 0.43 1.14 1.86 2.64 3.22
Sum ( ITR Area)
Sum ( Area)= 4.34%
Calculation of the sensitivity within SRC
• ALM has tried to approach the sensitivity formula for a variation of 1%.• We can write that the value of a loan of a nominal 1 and of annual coupon C is equal (with a
single discount rate) to:
• The change in value of the loan to an increase of 1% is written as:
• For a loan, we recall that if rates rise, its value decreases.• The cash flows Gap represents the trades to be set up to immunize the position.
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nn
nnn
nn
n
pp
nn rrr
Crr
CrCV)1(
1)1(
11)1(
1)1(
),(1
nr
1%)1,(),(%)1,(
nn
nnnn
rrVrrVrrVV
Calculation of the sensitivity within ALM
• If the trade to be set up is a loan and is not hedged, the entity will realize a gain if rates rise.• To characterize this gain, we will write that the change in value of the loan must be positive and will be
calculated as follow :
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nnn
nnn
nn
nnn
nnn
n
nnn
nnn
nnn
nn
nn
nnn
nnn
rr
rrr
rrrrr
rrrrrrrr
rrrrrrVV
%)11(11
%1%1
%)11(%)1(1%)11(%1
%)11(%)1(%1)%1(%)11(
%)11(%)1(%)1(%)11(%)11(%)1(
%)11(1
%)11(11
%11%)1,(1
Prepayment modelling:Prepayment modelling:
• Step 1 - Calculation of the outstanding loan balance
• Step 2 - Calibration of the seasonality parameters by stratification
• Step 3 - Calibration of the parameters of seasoning by stratification
• Step 4 - Calibration of the dependence on interest rate
• Step 5 - Validation : consistency & predictive power
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Step 2 - Modeling of the seasonality
Stratification :To avoid rate effect on seasonal coefficients, we sort the couples (i,t) of loan i and date t in 10 divisions that we call “strate”.
Prepayment rate by division
Minimization
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Step 4 – PP Dependence on interest rates • In theory, there is a level of interest rates at which all rational agents would have to
prepay. Thus we seek a function with a “threshold effect" to illustrate the dependence of PP on interest rates.
• Arctangent function with rate dependent coefficients
• Minimization
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Sensitivity of the NAV
The NAV of the 5-year bond paying a 4% yield is the following :
Year Rate Cash Flow Df « Rate" Discounted Cash Flow
Notional : 1 1,30% 4 0,987 3,9
100 2 1,60% 4 0,969 3,9
Coupon : 3 2,10% 4 0,940 3,8
4% 4 2,50% 4 0,906 3,6
5 2,80% 104 0,871 90,6
Total 105,8
Goal. Compute the NAV of the bond after an increase of the yield curve of 0.5%.
Step 1. Compute the new discount factors.
Year Rate Rate +0.5% Cash Flow Df « Rate+0.5%" Discounted Cash Flow
Notional : 1 1,30% 1,80% 4 0,982
100 2 1,60% 2,10% 4 0,959
Coupon : 3 2,10% 2,60% 4 0,926
4% 4 2,50% 3,00% 4 0,888
5 2,80% 3,30% 104 0,850
Total
Exercice
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