ICAAPCHALLENGES FOR THE

BOARD

Dr David Bobker

Asian Institute of Finance

ICAAP

• Quantified assessment is required

• Pillar 1 is just a starting point

• Cannot rely on standardised approach

• Stress testing key element – in particular reverse stress testing= inverse risk logic

Challenges for the board

• Understanding the risks

• Setting the risk appetite

• Credible ICAAP and capital adequacy

Understanding the risks• Cannot wholly delegate to management –

required to sign off on capital• Regulator placing more responsibility on the

board• Quantified risk must be the basis of an

ICAAP• Is the board able fully to understand the

quantum of risk even at a broad level?• Examples: interest rate risk; concentration

risk

Some questions for the board

• Has the board actually considered its own ability?

• What can the board do if it believes it needs additional capability?

• Is board making use of bank’s own professionals?

Challenge 2 setting appetite

• Understand what is appetite?

• DEFINITION: appetite=decision whether or not to accept the current situation with regard to all identified potentially catastrophic scenarios

• Requires careful consideration of the meaning of catastrophe AND identification of the catastrophic scenarios

Inverse Risk Logic

• Process of working backwards from potential catastrophes to drivers and associated control failures

• Opposite of usual approach of considering lots of scenarios and asking what is their effect

• Focuses only on catastrophe

• But what is catastrophe?

Catastrophe and leverage

• Loss of only a proportion of capital is catastrophic

• Suppose you can only afford to lose 30% of capital then YOUR EFFECTIVE LEVERAGE IS 3 TIMES ACTUAL

• Second – if the “probability” of loss of capital (per Basel) is 0.1% then the corresponding probability of losing 30% of capital is much greater

How much can you lose?

RegulatoryCapital

RISK WEIGHTED

ASSETS RISK ASSET RATIO

8%

Safetymargin

How much can you lose?

RegulatoryCapital

RISK WEIGHTED

ASSETS RISK ASSET RATIO

8%

Loss of capital

NON VIABLE

Leverage principle

RegulatoryCapital

Very small compared to asset base – significant compared to capital

RISKY ASSET BASE

Final Challenge

• Board needs to ensure there is a CREDIBLE ICAAP and ADEQUATE CAPITAL

• This may put it head on with Executive Management’s plans

• It is then a matter of choice for board members

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THANK YOUTHANK YOU