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8/11/2019 Brendan Mcinerney PDF
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Group Risk Control
CC Risikocontrolling
Credit & Counterparty Risks
RCO
Intranet-Based Distribution of Credit Risk Modeling
Technology and Ex Ante RoRACCalculations
Presentation for the Seminar on EU insolvency law Reform of the capitaladequacy DirectiveBudapest, September 26, 2002
Brendan McInerney
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Dresdner Bank AG Title of presentation Date 2
Group Risk Control
CC Risikocontrolling
Credit & Counterparty Risks
RCO
Contents
Introduction
Overview of Concepts
Fundamentals of Multi-Period Calculations
ExPLORER Current Features
ExPLORER Screen Shots
Outlook
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Dresdner Bank AG Title of presentation Date 3
Group Risk Control
CC Risikocontrolling
Credit & Counterparty Risks
RCO
Central Role of Banks in Risk Transformation
One of the fundamental roles of banks in an economy is theassumption, monitoring and mitigation of risks.
In the current business environment of the global bankingindustry, efficiency in performing these tasks has become
a clear driver for competitive advantage.
Overriding goals of risk control and risk management:1. Measurement of risks and their drivers2. Ensure appropriate returns for the assumption of risk
3. Optimize risk-return trade-off
Ultimate Goal:Creation of Shareholder Value
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Dresdner Bank AG Title of presentation Date 4
Group Risk Control
CC Risikocontrolling
Credit & Counterparty Risks
RCO
Why are Credit Portfolio Models Relevant?
Banks face competition from debt capital
markets in their
traditional lending business(disintermediation)
Banks traditionally make lending (buy)
decisions on a stand-alone basis, often
employing return on regulatory capitalmetrics instead of measures based on risk
contribution
Shareholders are demanding risk
transparency
Shareholders are demanding superior
risk-adjusted returns
Banks face increasing competition from
asset managers who now offer exposure
to the same asset classes (I.e. high-yieldbonds or syndicated loans) as an
alternative to investing in bank equity
Buy-SideCompetition Sell-SideCompetition
Banks have an overriding need to identify the economic value
associated with transaction and business activities
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Dresdner Bank AG Title of presentation Date 5
Group Risk Control
CC Risikocontrolling
Credit & Counterparty Risks
RCO
Risk-Adjusted Return Metrics: Why Bother?
Return Metrics as an Input to the Credit Decision Process
In order to determine whether to commit to a given transaction or not, an
assessment regarding the profitability of the transaction is necessary
Need for Ordinal Ranking of Proposed Transactions Necessitates:
Definition of methodology to calculate common-sized return metric
Harmonization of input parameters
Distribution channel for transaction pricing
Organizational buy-in and consistent implementation
Potential Application of Hurdle Rate
Through the definition of a minimum return expected from individual
transactions (Hurdle Rate), the common-sized return metric can be used for
an explicit decision rule in the credit process.
Choice of Type of Capital: Return on Regulatory Capital (RoRC) vs. Return on Risk
Capital
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Dresdner Bank AG Title of presentation Date 6
Group Risk Control
CC Risikocontrolling
Credit & Counterparty Risks
RCO
Dresdner Banks Approach to Risk Adjusted Return Metrics
Return Metrics are calculated during the origination process and
submitted as part of the approval process
Calculation of Return Metrics is automated to ensure consitent results
Automation achieved via an Intranet-based application: ExPLORER
All calculated transactions can be saved and used as the basis for
analysis of various risk / reward measurement methodologies and for
support of marketing strategies
Best practice portfolio managementstarts at the point of origination
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Dresdner Bank AG Title of presentation Date 7
Group Risk Control
CC Risikocontrolling
Credit & Counterparty Risks
RCO
Credit Risk Modeling Framework
Acquisition
and Pricing of
Proposed
Transactions
Integration of all
booked deals
in reference
portfolios
Portfolio
Credit Risk
and RoRAC
Measurement
Portfolio
Risk/Return
Reporting
and Analysis
Active Portfolio
Optimization
Functions
Portfoliocreditriskprofilebyreferenceportfolioasinputforpricingofproposedtransactions
basedonamarginalriskimpact
Performancemeasurementonthebasisofimprovementsinrisk-adjustedreturnmetricsand
relativetoapplicablebenchmarks
Portfolioreportsandanalysisasinputforportfolio
optimization
Portfoliocreditrisk/returnprofileasaninputfor
portfoliooptimizationdecisions
Integrationofportfoliorisk/returnmetricsintoreportingandanalysis
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Dresdner Bank AG Title of presentation Date 8
Group Risk Control
CC Risikocontrolling
Credit & Counterparty Risks
RCO
Risk Quantification and Loan Pricing Infrastructure
Data Preprocessing
for Portfolio Risk/
Return Calculations
Results by
Reference Portfolio
OverallBranchA
BranchB
DivisionC
DivisionD
Etc.
Assignmentofcreditriskpara-meters(EDF,LGD,UGDetc.)ConsolidationofAccountIDtoObligors
Applicationofcurrentmarketconditions
PortfolioAnalysis
Analysisofrisk/
returncontributionbyvariousdimension
(country,industry,rating,productetc.)
IdentificationofriskconcentrationRiskAdvisorytoseniormanagementInputtoPort.Optim.
Active PortfolioManagement
Risk/Return
OptimizationExecuteTrades
PerformanceMeasurement
Buy,
hedge
Input for RoRACLoan Pricing Process
Basedonmarginal
contributiontoportfoliorisk
EconomicP&L
CreditVaR Limitmonitoring
Heterogeneous
Source Systems
SystemA
SystemB
SystemC
SystemD
SystemE
Etc.
Data Integration /
Data Warehouse
Integrationofport-foliodatafromvarioussourcesystemstoacommonplatformStandardizeddatastructures
ObligorIdentification
Sourceforinternalandexternal
Portfolio Risk/
Return Calculations
Riskcalculations
separateforeachreferenceportfolio
Stresstesting
SensitivityAnalysisMark-to-Model
valuations
Calculation ofRoRAC based on
User Inputs
Originationo
fnewl
oana
ssets
UtilizationofIntranet-basedloanpricing
tool
sell,
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Dresdner Bank AG Title of presentation Date 10
Group Risk Control
CC Risikocontrolling
Credit & Counterparty Risks
RCO
Credit Risk Methodology: Overview
The Drivers of the Loss Distribution of the Reference Portfolio
UL
Economic Capital (Credit VaR):
J oint Default Correlations of obligorsimpose shape (leptokurtosis, fat tail) on
the portfolio loss distribution The amountof outliers beyond a certain cut-offdetermines Credit VaR in a quantile
calculation.
Driver of the Unexpected Loss:
Full probabilistic revaluation of the assets
at the end of the time horizon yieldsunexpected loss on a stand-alone basiswhich is subsequently aggregated to
the portfolio level.
Loss Gain
Driver of the Expected Loss:
Default Probabilities of Obligors (e.g. EDF from KMV Credit Monitor; calibration of internal ratings)Loss Given Defaults (LGDs) of Exposures: Capture actual losses net of mitigating factors (e.g. collateral)Usage Given Default (UGD): Incorporate the draw-downs on open limits (e.g. Credit Lines Undrawn)Time Horizon:Time frame for which the effects of credit migration in the future is to be evaluated.
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Dresdner Bank AG Title of presentation Date 11
Group Risk Control
CC Risikocontrolling
Credit & Counterparty Risks
RCO
The Evaluation of Single Exposures WithinThe Context of a Portfolio of Credit-Risky Assets
CUL
RCC PP
B
B GainLoss
ULPULP
Economic Capital(Credit VaR)
Risk Contribution of
Single Exposure to the
Variance (Risk)
of the Overall Portfolio
Economic
Capital Allocatedto Single Exposure
ExposureSingletoAllocatedCapitalEconomic
)AlonedtanS(LossExpectedturnRe:RORACB
Ch i f R f P tf li Th Eff tOf Di ifi ti
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Dresdner Bank AG Title of presentation Date 12
Group Risk Control
CC Risikocontrolling
Credit & Counterparty Risks
RCO
Choice of Reference Portfolio: The Effect Of Diversification onMeasured Risk
Branch A
Branch B
Branch C
Branch D
RegulatoryCapital(8% ofRWA)
83%
43%
67%
30%
100%
100%
100%
100%
Compared with:
Regulatory Capital50% Reduction of
measured risk
through integratedcalculation of
branch portfolios
Sum of risk of
individual branch
portfolios (=100%)Selected Branches
at a 99,95%
Confidence Level
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Dresdner Bank AG Title of presentation Date 13
Group Risk Control
CC Risikocontrolling
Credit & Counterparty Risks
RCO
Transaction Pricing Based On RoRC- and RoRiskCap-Metrics
Regulatory Capital Usage 2)
Net Return after TaxesRoRC =
Net Return after Taxes
Risk Capital1)RoRiskCap =
Spread and Fee Revenues of Credit Transaction (Originating Unit Income)
- Standardized Administrative Costs
- Expected Loss due to Credit Risk (Standard Default Costs)
- Expected Loss due to Transfer Risk
- Liquidity Costs (Long Term Funding Policy)
+ Capital Benefit
- Taxes (based on location specific tax rates)
= Net Post-Tax Profit
StylizedP&LStatement
1 BasedontheGroupRiskCapitalMethodologyversion2.0whichreplacedEconomicCapitalversion1.5
2 BasedontheTargetTierICapitalRatioof7.25%ofrisk-weightedassets(BaselI)oranestimationofBaselIIAdvancedApproachcapital.
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Dresdner Bank AG Title of presentation Date 14
Group Risk Control
CC Risikocontrolling
Credit & Counterparty Risks
RCO
EconomicValueAdded(EVA)Transformation fromReturn on Capital Metrics
Net Return after Taxes
Risk CapitalRoRiskCap =
(Net Return after Taxes) (Risk Capital * Hurdle Rate)EVA =
After tax hurdle rate was set by Allianz Group at 9,95% for Dresdner Bank
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Dresdner Bank AG Title of presentation Date 15
Group Risk Control
CC Risikocontrolling
Credit & Counterparty Risks
RCO
The Impact of Applying Regulatory vs. Risk Capital to thePricing of Single Transactions
Basic Intuition: Byreplacingtheregulatorycapitalusageasthebasisforrisk-adjustedpricingbyriskcapital,yetanotherdriverofdifferentiationamongproposedtransactionsisintroduced.
Result: Ordinalrankorderofsingletransactionsandtheassociatedbanking
relationshipsmaychangedramatically,especiallytowardstransactionswithobligorsofhighcreditquality.
RegulatoryTierIandIICapitalUsageforCorporates
MeasuredCreditRisk(RiskCapital)
TargetTierICapitalRatio
RoRiskCap
>
RoRC
RoRiskCap