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Regional workshop BCCL-METAC

Joint risk assessment of cross border banking groups

BEYROUTH, April 25th, 2012

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BANQUE DE FRANCE Joint risk assessment of cross border banking groups

JEAN-LUC QUEMARD – IBFI – April 25th, 2012

INTRODUCTION

• Risk assessment is a basic work of supervisory colleges: But how to do it ?

• Where are we in the European Union ? • Guidelines have been recently published by the

European Banking Authority; • Very comprehensive ; • Package in course of implementation in EU; • For third countries : good starting point to elaborate a

project on risk assessment ?

• Basel II: a prerequisite?

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PRUDENTIAL FRAMEWORK: BASEL II AND BASEL III

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– Pillar 1: Quantitative assessment of capital and liquidity.

– Pillar 2: Supervisory Review and Evaluation Process (SREP) and Internal control system and Internal Capital Adequacy Assessment Process (ICAAP).

– Pillar 3: Detailed public disclosure on risks and capital

adequacy.

BASEL II AND III: STILL THREE PILLARS

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Source : Moody’s Analytics

BASEL II AND III : STILL THREE PILLARS Pillar I Ratios

Capital Ratios

Capital

Tier 1 Tier 2

RWA

Credit

Standard

IRB F

IRB A

CCR Derivative Exposure

CEM

EPE

CVA

WWR

Market

Standard

IMA

VAR

Stressed VAR

IRC

Operational

BIA

Standard

AMA

Liquidity Ratios

LCR NSFR

Leverage Ratios

Pillar II Supervisory

Review Process

Pillar III Market

Discipline (reporting)

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Internal control system and Internal Capital Adequacy

Assessment Process (ICAAP)

Capital requirements (Pillar 1)

Allocation of Capital

Dialogue

Examinations

Conclusions

Additional capital requirements

Satisfactory Unsatisfactory

Corrective actions

Supervisory Authority

Review and evaluation of internal mechanisms, adequacy

of risks, compliance with minimum requirements … via

the Risk Assessment System (RAS)

Supervisory Review and Evaluation Process

(SREP)

Calculation of Pillar 1 requirements

Identification, measurement, monitoring and management of all

material risks

Evaluation of internal capital commensurate with risk profile

Institutions

PILLAR 2

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Credit riskOperational risk

Market risk

Interest rate riskin the banking book

Liquidity risk Quality of internal control and internal audit,

Professionnalism in thedifferent fields of activities

Concentration risk (single, sector and geo.)

Strategic and reputational risks

Other risks

Pillar 1

Pillar 2

A comprehensive assessment of risks PILLAR 2

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FROM A NATIONAL RISK ASSESSMENT PROCESS

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• Necessity of a National assessment process

– In Europe based on Directive 2006/48/CE, especially Annex XI (“Technical criteria on review and evaluation by the competent authorities”)

=> so risk assessment already existed in the European Union but there were not harmonized.

– Elaborated at the French level: The ORAP 2 methodology:

- ACP’s risk assessment system (cf. Commission Bancaire Annual Report 2007: “The risk assessment system used by the General Secretariat of Commission bancaire”),

- Encompasses the Directive’s criteria (cf. Annex 1: mapping of Annex XI criteria with ORAP 2 criteria).

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• Overall assessment process (illustrative adaptation):

Overall assessment on a 1 to 4 scale

Overal organisation of the insitution, Internal control framework, Risk monitoring, management and control framework

or and/or No Pillar 2 measure seems necessary

Analysis of quantitative data related to (1-4)

Pillar 2 measures, other than capital add-on,

seem necessary

Analysis of qualitative data related to (1-3)

Activity Credit risk Concentration risk Market risk Operational risk Liquidity risk

+ Interest rate risk Internal control Corporate governance Results and profitability Own funds

Capital add-on requirement seems

necessary

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• Example of indicators analysis in the assessment process

Institution XXXXXX

indi

cato

r va

lue

rank

of t

he

inst

itutio

n

Qua

rtile

num

ber

of

obse

rvat

ions

high

est v

alue

low

est v

alue

med

ian

valu

e

Average annual variation of the own funds requirements (credit and market) between 2004 and 2007

10,0% 2 1st 24 15,0% -5,0% 7,0%

Weight of CIB in the NBI - Weight of retail in the NBI - 3 years average (2005/2007)

-25,0% 8 2nd 24 70,0% -100,0% -40,0%

Weight of investment banking in the CIB NBI in 2007 60,0% 3 1st 24 70,0% 5,0% 20,0%

Weight of corporate credit - Weight of retail credit (2007) -50,0% 20 4th 24 40,0% -70,0% 1,0%

Weight of credit/risks on foreign counterparties 2007 20,0% 12 2nd 24 50,0% 0,0% 30,0%

Act

ivity

indi

cato

rs

Weakness due to specific elements

Indicator to be relativised

Confirmed weakness Indicator mitigating the risk profile Indicator without consequence for Pillar 2 or not material for the institution

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• Development of risk management check lists

• Consist in a check list of the main points that have to be analysed and aim at facilitating the qualification of the risk management framework, helped by a hierarchy made between questions :

- Level 1 priority indicator : questions where a « no » answer presume issues with the risk management

- Level 2 priority indicator : questions where a « no » answer presume difficulties that need corrective actions without anyway making concerns about the global efficiency of the risk management framework

- Level 3 priority indicator : questions where a « no » answer presume a risk management framework which is not that perfect

• According to the number of no and the number of level priority of indicator for each criteria, the assessment could be:

- Unsatisfactory

- To be enhanced

- Satisfactory

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ILLUSTRATION OF A MATRIX TO COMBINE SCORES

Rating matrix

Risk management

Unsatisfactory To be enhanced Satisfactory

Risk profile

Very low risk 2 1 1

Low risk3 2 1or important financial

room for manoeuvre

Medium risk4 3 2Or limited financial room

for manoeuvre

High risk of breach in the prudential

regulation 4 4 3or no financial room for

manoeuvre

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• Capital requirement methodology (illustrative)

a) The institution is ranked on a 4 grade scale of risk;

b) For each grade, a range of ratio is set up: – For parent companies ranges are set up by comparison

with ratios communicated to the market by institutions (National and foreign) with the idea that they ensure a proper coverage of their risks

– For subsidiaries of these groups ranges are set up: Taking into account their belonging to a major national

banking group By reference, for the most material of them, to the

objectives that they fixed themselves in term of T1 ratio

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• Capital requirement methodology (illustrative) c) Taking into account the risk profile and the current and potential

situation of the institution:

Risk level Ranges of tier 1 ratio

Parent companies Subsidiaries

1 lowest [7,50 % - 8,00 % [ [4,00 % - 6,00 % [ 2 [8,00 % - 8,50 % [ [6,00 % - 7,00 % [ 3 [8,50 % - 9,00 % [ [7,00 % - 8,00 % [ 4 highest [9,00 % - beyond [ [8,00 % - beyond [

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JOINT RISK ASSESSMENT OF CROSS BORDER BANKING GROUPS

METHODOLOGY

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Joint Risk Assessment and Decision (JRAD)

• New task for European college in 2011: joint decision on Pillar 2

– The College has to agree on a common evaluation of

the Group, its strategy, its risk profile, with a view to a joint decision on Pillar 2

– “Guidelines for the joint assessment of the elements covered by the supervisory review and evaluation process (SREP) and the joint decision regarding the capital adequacy of cross-border groups (GL39), EBA, December 2010”

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Joint Risk Assessment and Decision (JRAD)

– Development of new working methods and standardization of the nature and content of the information exchanged on the risk profile:

a common template for reporting on the risk profile

of all entities stemming from the JRAD EBA Guidelines

an agreed sharing of roles taking into account the significance of every supervisor and the relevance of local entity(ies).

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OVERVIEW OF THE PROCESS FOR THE JOINT RISK ASSESSMENT AND DECISION (JRAD) ON RISK-BASED CAPITAL ADEQUACY

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THE JOINT ASSESSMENT OF RISKS FACTORS AND RISK MANAGEMENT FACTORS IN THE COLLEGE OF SUPERVISORS

(SREP)

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TRANSLATION OF NATIONAL RISK ASSESSMENTS THROUGH COMMON TEMPLATES AND SCORING SCALES

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TRANSLATION OF NATIONAL RISK ASSESSMENTS THROUGH COMMON TEMPLATES AND SCORING SCALES

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SCORES FOR THE ASSESSMENT OF RISK FACTORS

Score Description

1 Low risk of significant impact on the prudential elements of the group or its entities.

2

Medium-Low risk of significant impact on the prudential elements of the group or its entities. Nonetheless, a change in the situation could relatively quickly have a significant impact, and thus the risks or weaknesses considered must be monitored.

3 Medium-High risk of significant impact on the prudential elements of the group or its entities. The entity’s risk control thus requires supervisory attention.

4 High risk of significant impact on the prudential elements of the group or its entities. The entity’s risk control thus requires heightened supervisory attention.

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SCORES FOR THE ASSESSMENT OF RISK MANAGEMENT AND CONTROL

Scores Description

1 A high level of risk management and control. The risk management and control framework is clearly defined and fully compatible with the nature and complexity of the institution's activities.

2 An acceptable level of risk management and control. The risk management and control framework is adequately defined and sufficiently compatible with the nature and complexity of the institution's activities.

3

The risk management and control needs improvement. The risks are insufficiently mitigated and controlled, leaving too high a residual risk for the institution. The risk management and control framework is hardly defined or insufficiently compatible with the nature and complexity of the institution's activities.

4

The risk management needs drastic and/or immediate improvement. The risks are not or hardly mitigated and poorly controlled. The risk management and control framework is neither defined nor compatible with the nature and complexity of the institution's activities.

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• To do: thanks to the matrix p12, please calculate the combined scores.

EXAMPLE: RISK ASSESSMENT AND COMBINED SCORE

Risk factors Score for Risk profile (1)

Score for risk management and control assessment (1)

Combined score Year N

Combined score Year N-1

Financial position 2 2

Own funds 1 2

Internal control framework NA 2 2

Business and strategic risk 1 1

Credit risk Medium High (3)

Satisfactory (1) 1

Market risk

Medium High (3)

To be enhanced (2) 3

Operational risk Medium Low (2)


Liquidity risk Medium High (3)

Satisfactory (1) 3

Concentration risk Low (1) Satisfactory (1) 1

Interest risk in the Banking book Medium high (3)


Overall score ? 1

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EXAMPLE: RISK ASSESSMENT AND COMBINED SCORE BY A NATIONAL SUPERVISOR

Risk factors Score for Risk profile

Score for risk management and control assessment

Combined score Year N

Combined score Year N-1

Financial position 2 2

Own funds 1 2

Internal control framework NA 2 2

Business and strategic risk 1 1

Credit risk Medium High (3)

Satisfactory (1) 2 1

Market risk

Medium High (3)

To be enhanced (2) 3 3

Operational risk Medium Low (2)


Liquidity risk Medium High (3)

Satisfactory (1) 2 3

Concentration risk Low (1) Satisfactory (1) 1 1

Interest risk in the Banking book Medium high (3)


Overall score 2 1

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SUMMARY TABLE OF THE JOINT ASSESSMENT OF RISK AND CONTROL FACTORS (Not always used)

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SUMMARY TABLE OF THE JOINT ASSESSMENT OF RISK AND CONTROL FACTORS

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JOINT ASSESSMENT OF THE ICAAP PROCESSES AND METHODOLOGIES FOR CROSS BORDER

GROUPS

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COMMON TEMPLATE FOR TRANSLATING THE ICAAP PROCESS ASSESSMENT

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COMMON SCORES FOR ASSESSMENT OF THE ACCURACY OF THE ICAAP METHODOLOGIES AND PROCESSES

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SUMMARY TABLE OF THE ICAAP PROCESS ASSESSMENT

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JOINT ASSESSMENT OF COMPLIANCE WITH THE VARIOUS MINIMUM REQUIREMENTS

SET OUT IN THE CRD

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COMMON TEMPLATE TO REPORT ASSESSMENTS OF COMPLIANCE WITH THE CRD

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SUMMARY TABLE ASSESSMENT OF COMPLIANCE WITH THE CRD REQUIREMENTS

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DETERMINATION OF THE ADEQUATE LEVELS OF OWN FUNDS AT THE GROUP AND ENTITIES LEVELS

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COMMON TEMPLATE TO REPORT THE PRELIMINARY INDIVIDUAL RESULTS OF THE RISK-BASE CAPITAL REQUIREMENTS

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SUMMARY INFORMATION ON RISK-BASED CAPITAL ADEQUACY OF GROUP

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JOINT RISK ASSESSMENTS CHALLENGES

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• The main JRAD challenges: – Understanding each other for an efficient

coordination: essential elements/features of national SREPs, local legal and prudential constraints …

– Coordinating the results of different risk assessments: difficult aggregation exercise for Home in charge of using its expert judgment while reflecting each Host RAS

– Assessing the appropriate allocation of capital within a group

– Elaborating a forward looking analysis (time to coordinate then to reach agreement)

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• The main JRAD challenges: – Conducting a “full” ie comprehensive RAS each year or

deciding on a specific road-map eg by focusing on different risks areas each year

– Usefully associating the group to the global RAS process

– Adapting working methods and planning: how preparing the common report all together and in due time?

– Speedy circulation of information (foster efficiency in exchanging respective RAS)

– Cooperation process between Home and Host authorities pursuant to Directive 2009/11/CE to reach a joint decision on: assessment on the risk profile of the group “Pillar 2” capital requirements

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CONCLUSION

– Not relying on a too mechanistic approach

– Only the first stage currently in course of implementation in Europe

– Are all the stages necessary?

– Not forgetting the weight of each entity into the group

– A step by step and cautious approach could be recommended.

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Annex 1: Mapping between directive 2006/48/CE

and ORAP 2 criteria

Directive 2006/48/CE criteria References ORAP 2 criteria Governance Article 22 Strategy and organisation

Credit risk Annex XI-1 Quality of credit portfolio Coverage of credit risk

Market risk Annex XI-1 Market risk Operational risk Annex XI-1 Operational risk

Credit risk stress scenarii Annex XI-1.a) Quality of credit portfolio

Concentration risk Annex XI-1.b) Concentration risk Residual risk associated with rhe use of recognized credit risk mitigation techniques

Annex XI-1.c) Coverage of credit risk

Level of own funds regarding the weight of its securitized assets Annex XI-1.d) Own funds

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Annex 1: Mapping between directive 2006/48/CE and

ORAP 2 criteria

Directive 2006/48/CE criteria References ORAP 2 criteria Liquidity risk Annex XI-1.e) Liquidity risk Impact of diversification Annex XI-1.f) Own funds Results of stress tests for institutions using an internal modal to calculate market risk capital requirements

Annex XI-1.g) Market risk

Implicit support to a securitisation Annex XI-2. Quality of credit porfolio, own funds

Ability to sell or hedge positions within a short period without incurring material losses under normal market conditions

Annex XI-3 Market risks

Adequacy between own funds and risks Art. 123–p 1 Own funds

Internal control Art. 123–p 2 Organisation of internal control

Interest rate risk Article 124-5 Interest rate risk in the banking book

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Annex 2: Indicators taken into account

Activity: Average annual variation of own funds requirements (2004/2007) Weight of CIB in NBI – Weight of retail in NBI, 3 years average Weight of investment banking NBI in CIB NBI Weight of exposure on corporate – weight of exposures on retail Weight of exposure on foreign counterparties Total staff Weight of staff abroad Total balance sheet “Staff / Total balance sheet” ratio

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Annex 2: Indicators taken into account Results and profitability: Cost to income ratio (3 years average) Spread between 2007 and 2006 cost to income ratio, for the group

and each of its business lines % of NBI resulting from activities with hedge funds 2007 crisis impact of NBI

Credit risk: % of low quality assets (according to Banque de France rating) % of non investment grade assets in the corporate portfolio % of small or medium firm assets in the corporate portfolio Amount of missing provisions considering expected losses Study on the rigourisity of the internal rating system Impact on own funds requirement of a credit stress scenario

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Liquidity and maturity mismatch: Lowest liquidity ratio in 2007 Exposure to credit institutions Difference between refinancing agreements granted and refinancing

agreements received “Short term assets (≤1 year) / short term liabilities (≤1 year)” ratio Amount of customer’s liabilities in the balance sheet Amount of securities’ liabilities in the balance sheet 1 year maturity mismatch 5 years maturity mismatch

Operational risk: Total balance sheet Net Banking Income Total amount of operational losses


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Internal control: Permanent control staff Periodic control staff Compliance staff

Market risks: Average amount of trading book Amount of financial assets at fair value through profit or loss Average value at risk ROE before tax on the investment banking activity

Coverage of credit risk : “Cost of risk / NBI” ratio calculated at the group and business lines

levels “Impaired assets / NBI” ratio


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Concentration risk: Total amount of large exposures / own funds ratio HHI data on concentration

Interest rate risk in the banking book: Impact on own funds of a 200 bp stress on interest rate

Strategy and organization: “Asset management assets / total balance sheet” ratio “NBI / asset management assets” ratio “Asset management assets / own funds” ratio Liquidity lines granted in securitization operations “Cost of acquisitions / total balance sheet” ratio “Cost of acquisitions during the last year / own funds” ratio


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Own funds: Amount of hybrid capital in tier 1 ROE on tier 1 capital Leverage ratio (tier 1 capital / total balance sheet) “Results / average RWA” ratio “Results / RWA annual variation” ratio “Goodwill / Core capital” ratio “Goodwill / operating profit” ratio “Core capital / Own funds requirement” ratio ICAAP


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Annex 3 : Development of risk management check lists

- Extract of a check list :

1.

The institution has determined limits based on the indicators used for measurement and monitoring of liquidity risk (article 33 of regulation n° 97-02)

Yes

Comments No

D/K

2. Limits level is regularly reviewed, at least once a year(article 33 of regulation n° 97-02)

Yes

Comments No

D/K

3. Limits are set up by the executive body and, if appropriate by the decision-making body (article 33 of regulation n° 97-02)

Yes

Comments No

D/K

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Annex 3 : Development of risk management check lists (continued)

Number of answers "No" to the questions… Quality of risk management

Level 1 Level 2 Satisfactory To be

enhanced Unsatisfactory None None Y N N

Moderate Y Y N High N Y N

Moderate None Y Y N Moderate N Y Y High N N Y

High None N N Y Moderate N N Y High N N Y

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