Challenges in the evolution of financial risk analysis by applying Basel III approaches
CIS Bankers Conference
Ioannis Akkizidis | Global Product Manager | Wolters Kluwer Switzerland
email: [email protected]
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Basel III: Analysis Challenges
Credit Exposures
Credit Value Adjustments
Wrong Way Risk
Liquidity Risk
Central Counterparties & Systemic Risk
Data Aggregation
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Financial & Risk Data
Deterministic & Stochastic Scenarios
Market & Credit Risk Factors
Stress Conditions
Normal Conditions
Full Re-Pricing at each Future Time
Type of Exposure
Peak
Expected (PE)
Effective (EE, EPE)
Default & Migration Analysis
Applying Exposure
Valuation Adjustments
Wrong Way Risk
Exposure at Default
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Exposure Analysis
Credit Exposures
§ Stochastic & Deterministic Scenario Generation
§ Market
§ Credit
§ Behavior
§ Stress VaR
§ Data & Proxies
§ Dynamic Exposures
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Spreads, Ra+ngs & Market
Discount factors
Exposures
LGD
WWR
Credit and Debt Value Adjustments
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Credit Value Adjustments
Market LGD
Discount Factor
Expected Exposure
Δ(Spreads)
𝐶𝑉𝐴 = (𝐿𝐺𝐷𝑀𝐾𝑇 ) ∙.𝑀𝑎𝑥 10; 𝑒𝑥𝑝 6−𝑠𝑖−1 ∙ 𝑡𝑖−1𝐿𝐺𝐷𝑀𝐾𝑇
< − 𝑒𝑥𝑝 6−𝑠𝑖 ∙ 𝑡𝑖𝐿𝐺𝐷𝑀𝐾𝑇
<= ∙ 6𝐸𝐸𝑖−1 ∙ 𝐷𝑖−1 + 𝐸𝐸𝑖 ∙ 𝐷𝑖
2<
𝑇
𝑖=1
Marginal Default Probabilities Expected Exposures Market data Implied
The Basel formula for CVA is defined as following:
𝐶𝑉𝐴 ≈ &1 − 𝛿̅+, 𝐷(𝑡𝑖) ∙ 𝑠(𝑡𝑖−1, 𝑡𝑖) ∙ 𝐸𝐸(𝑡𝑖) 𝑛
𝑖=1
Specific / General WWR § Extending to downgrading risk
§ Market driven
§ Use of Proxies
§ Missing WWR
§ Missing DVA
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Reputation
Ratings & Δs Collaterals & Hedging
News & Rumours
Parameters on defining Counterparty Credit Spreads
Credit Spread
Recoveries & Market LGDs
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Integrating Credit Ratings & Credit Spreads data
Spreads
Ratings
Curves: Rates& Terms
Markets’ Driven
Institutions’ Driven
Mixed Model
Volatilities Correlations
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5 4 3
2
Willingness
Cred
itab
ility
t1 t2
t3 t4
t5
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Ratings
Time
Credit Spread Curve
A
AAA AA
CCC CC
C BBB
BB
B
t1
Credit Spreads & Ratings
t2 t3 t4 t5 t6 t7 t8 t9
Through-the-cycle(TTC) V Point-in-Time(PIT)
§ Credit Ratings
§ Set PIT
§ Migrates TTC
§ Credit Spreads (discounting)
§ Set & Re-priced TTC
§ Change (stressed) PIT
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Market LGD
Recovery
Market Expectations on
Recoveries
Value after Default Event
Liquidity after Default Event
Market LGD
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Strategies Political Decisions
Behavior Model
Seniority
Specific Wrong Way Risk
Collateralized Exposure (Credit Enhancements)
Net Exposure
Counterparty
Own Collateral
Idiosyncratic Events
§ Δ(Ratings) - Downgrading
§ Δ(Spreads)
Downstream effects:
§ Value
§ Liquidity
Unfavorable correlation between exposure and OWN counterparty credit quality
Idiosyncratic Risk
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Collateralized Exposure (Credit Enhancements)
Net Exposure (NetEAD)
General Wrong Way Risk
Counterparty
Idiosyncratic Sensitivity θι
Unfavorable dependence between exposure and correlated to counterparty credit qualities
Industry Sector
θκ
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θκ
Country
Bilateral CVA (Debt Value Adjustments)
Own Market LGD
Expected Exposure
Δ(Own Spreads)
Specific / General WWR
§ Considers Idiosyncratic Risk
§ Symmetry: ΣCPrisk = 0
§ Defining premium for both Cps
§ Defining the haircut on Deposit Guaranty
𝐵𝐶𝑉𝐴 ≈ '1 − 𝛿̅,-𝐷(𝑡𝑖) ∙ 𝑠(𝑡𝑖−1, 𝑡𝑖) ∙ 𝐸𝐸(𝑡𝑖) 𝑛
𝑖=1
− '1 − 𝛿𝐹𝐼;;;;,-𝐷(𝑡𝑖) ∙ 𝑠𝐹𝐼(𝑡𝑖−1, 𝑡𝑖) ∙ 𝑁𝐸𝐸(𝑡𝑖) 𝑛
𝑖=1
general WWR
CVA
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DVA
(Considering Own Default Risk)
Exposure to Systemic & Concentration Risk Analysis
θκ
θκ
Idiosyncratic Sensitivity θκ
Correlations
θκ θκ
Sector Country Industry
Sector Country Industry
CPA
CPB CPC
CPD
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Sensitivity profiles
θi,k (sectors k)
θi,0 (idiosyncratic)
Volatilities
Correlation matrix
Default CCC B BB BBB A AA
BB
Systemic change of ratings
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BBB Rating at starting analysis time
Migration period 1
Rating distribution at t1
Migration period 2
Default CCC B BB BBB A AA
Market Conditions Sensitivity to Credit
Risk Factors
t0
Markets
Stress Sensitivities
Stress Ratings
t1
t2
Rating distribution at t1 Default CCC B BB BBB A AA
The rating evolution
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Capitalisation of a Bank/CM exposures to CCPs
Clients
Intermediary / Guarantor
Clients
CCP
CM
CM
CM CM
CP
Trade Exposures’ Distribution
CM/Bank Exposure to
Qualified CCP
CM exposures to CCPs
Trade Exposures
CM exposures to Clients
Client exposures to
CM
Default Fund Exposures
Hypothetical capital
Scenario based capital
CM allocation based capital
Non-Qualified CCPs
High RW to Default Funded
(unfunded) Contributions
Trade Exposures applying bilateral
framework
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Liquidity Risk is based on integrated Analysis
Current & Future Credit
Risk
Financial Instruments
Current & Future Market
Risk
Liquidity Cash Flow
Events
Current & Future Behavior
Risk
Liquidity Reports
Integrations Stress
Stress
Strategies on Existing & Future
Liquidity View
Illustrating Liquidity positions
Stress
Asset Types
Cash Outflows
𝐿𝐶𝑅 =𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝐻𝑄𝐿𝐴
𝑇𝑜𝑡𝑎𝑙 𝑛𝑒𝑡 𝑐𝑎𝑠ℎ 𝑜𝑢𝑡𝑓𝑙𝑜𝑤𝑠 𝑜𝑣𝑒𝑟 𝑡ℎ𝑒 𝑛𝑒𝑥𝑡 30 𝑐𝑎𝑙𝑒𝑛𝑑𝑎𝑟 𝑑𝑎𝑦𝑠≥ 100%
Monitoring Liquidity
𝑁𝑆𝐹𝑅 = 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑠𝑡𝑎𝑏𝑙𝑒 𝑓𝑢𝑛𝑑𝑖𝑛𝑔𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑠𝑡𝑎𝑏𝑙𝑒 𝑓𝑢𝑛𝑑𝑖𝑛𝑔
> 100%
Basel III Liquidity Ratios
§ Liquidity Coverage Ratio
§ Net Stable Funding Ratio
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Liquidity Risk is based on integrated Analysis
Liquidity Risk
Funding Liquidity
Market Liquidity
Contractual Liquidity
Contingent Liquidity
Unexpected Cash Flows through Time Period
Unexpected Value and Cash at point of Time
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Intraday Liquidity
Largest net cumulative outflow Market Risk
Counterparty & Credit Risk
Behavior Risk
Contingent Payments
Cash Payments
Inter-banking Transactions
Intraday positions must be larger than banks’ end of
day net positions. Inter-banking Transactions
Payments
Central Bank facilities
e-money
e-money e-money e-money?
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Intraday L@R
Intraday L@R Intraday
L@R
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Financial Events
Finance
Risk
Financial & Risk Data
reconciled
Accounting Rules
Input
Market Data
Fictional Real (Observed)
Behavior &Scenarios
Fictional Real (Observed)
CP Data Descriptive
Statistical (PD) Input
Fictional Real (Observed)
Liquidity
Income Value
Output
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Financial & Risk Data Aggregation
Financial Events
Finance
Risk
ALM
Credit Risk
Liquidity Risk
Market Risk
Liquidity
Concentration Risk
DB
Aggregated Data
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Basel III
Credit & Counterparty
Risk
Market & Behavior Risks
Liquidity Ratios & Intraday
Data Aggregation
Systemic, Concentration & CCPs
Behaviour
Market Risk
Integration
Conclusions: the green field of analysis
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Specific & General WWR
Considering downgrading & Default including Own
Evolution of Exposures
Thank you !!!
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