christopher lotz

7/28/2019 Christopher Lotz

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Quantitative Risk Models at BaFin

BaFin is an integrated financial services supervisor

Line Supervision

(BA/VA/WA)

Cross-Sectoral Risk Modelling

(Q RM)

Detailed knowledge of thesector and individual firms

Model experience across allrisk classes and sectors

Responsible for Responsible for

Qualitative requirements

One face to the client

9 On-site inspections

9 Regulation

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Structure

AMA at BaFin

Critical issues in the model approval process

Pillar II

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Some statistics on AMA in Germany

15 AMA models in 14 groups (8 home / 7 host)

.

heavily biased downwards because of host banks

> 1 bn

Distribution of OR capital ca. 50% use insurance asrisk mitigation

1 m - 10 m

37% average deduction 12%

10 m - 100 m

100 m - 1 bn

27%

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AMA capital has stayed stable

J un 08 Dez 08 J un 09 Dez 09

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Audit activity has picked up after crisis

27 on-site inspections

planned or conducted 7

8

since 2007

5

6

Durat on o on-s te

inspections varies

heavily depending on3

4

first-time or follow-up

size and complexity1

2

20072008

20092010

0

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Overall Strategy: Road To Approval

1. Audit planning

-.

3. Audit report

4. Audit result

5. Follow up

Audit approach:

s or en e

< Principles based

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1. Audit Planning

< Determine audit strategy based on existing knowledge of firm

< Establish specific audit plan including audit assignments

< Re uest documentation

< Check documentation as preparation for on-site inspections

< Throughout planning phase, carry out one or more visits for

detailed discussions of model-related topics and overall

coordination of the audit approach

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2. On-site inspections

< Cover overall process from risk identification and risk capture

to reporting and use of model results

< Check correct capture, classification of and dependencies

between risks

< ev ew n erna mo e va a on process an resu s

< Assess impact on regulatory capital

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Audit report, result and follow up

3. Audit report

-

< Contains results and findings of the audit

< Discussion of findin s with senior mana ement

4. Audit result

< Does the implementation of the internal model satisfy internal

and external standards?

5. Follow up

e.g. ac on p an or reme a on, regu ar superv sory v s s

< Follow up inspections depending on complexity and speed of

change

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Standard structure of inspection reports

1. Framework and

organizational structure

3. Insurance and other risk

mitigation techniques

2. OR analysis

3. OR processes

4. Model validation

5. Management

.

2. External data

3. Scenario analysis

.

2. Reporting

3. Capital allocation and

4. BEICF

4. Modelling

ncen ves

4. Management

6. Internal Audit.

2. Stochastic model andcapital calculation

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Structure

AMA at BaFin


Pillar II

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Communication between firms and supervisors

Model documentation

Use test

Internal model validation

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Risks

demanded for the approval of an internal model.

< Supervisors may not be used to the complexity offirm-wide.

Therefore, a firm should

< take a proactive approach in presenting its model to theregulator,

< explain the compromises between competing demands,

,weaknesses, etc.

< build an ongoing relationship with its regulator.

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Model documentation

Use test


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Model documentation general remarks

Documentation is more than just the description of the

model, processes or risk management framework.

Documentation

< is the first impression supervisors get of a model

< acts as the main interface between firms and supervisors

Firms

< want to avoid lapse risk after education of supervisors

uperv sors

< need to make sure that the model complies with standards

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Model Documentation

D

Model Development Supervisory approval

cumentation

but the starting point for the model approval process!

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Model Documentation

Model Development

Documentation

Supervisory Model Approval

Documentation parallel to model developmentavoids hold-up.

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Model documentation

Use test


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Internal model use

Main benefits of an internal model:

Develo ment and im lementation forces a firm to understandits own risks.

The infrastructure improves the communication of risks.

Foundation Principle:Use must be sufficiently material to result in pressure toim rove the ualit of the internal model

However

the cultural chan e needed for an effective use of the modelcan take up considerable resources

the time needed for integration into decision making is oftenunderestimated.

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The model: One part of the RM framework

People RoutinesArchitecture Culture

ositions olicies

quantitative

modelassumptions, parameter

...

other

datastress tests

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Integration of an internal model

Consistency

Congruence

< In line with business strategy

Pervas on

< Embedded in processes and systems

Completeness

< Coverage of all significant risk drivers, portfolios, etc.

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Result: Internal model as a control

The output of the internal model is a control on financial

risks.

The infrastructure associated with the internal model is a

con ro on organ za ona r s s.

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Internal model use: Examples

A risk strategy should exist and should be

reflected in the budgeting process

Results of the internal model should appear on reports.

Are the reports of sufficient quality (ie. do they contain

analysis or recommendations for management actions?)

Can recipients explain their reports?

Model results should drive incentive mechanisms.

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Model documentation

Use test


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Supervisory Model Validation: Two Parts

Initial model approval

Auditin the framework for internal model validation

< Continued suitability of the model in a changing environment

< Changes in the environment or business strategy lead to

changes of the internal model

< Governance around model changes is established in a

model chan e olic

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An internal model...

is neither a crystal ball that predicts future risks,

.

It measures known risks, only. That is why it

has to constantly be challenged and updated to adapt to

changes in risk environment and

has to be supplemented by other risk management tools

such as stress testing and scenario analyses.

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Demands on an internal model

Simple and understandable

Explainable to senior management

Stable/Robust

Sensitive

Sma c anges in inputs

cause only small changesin outputs

The model reacts to

changes of risk

Includes all material

risk drivers

-

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Model risk

is the risk that the model can not cope with the tensions

between these diverse demands.

Possibly, because of changes in the characteristics of

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