Risk Adjusted Performance Measurement - the Economic Profit Concept at Deutsche Bank From Theory to...

Risk Adjusted Performance Measurement - the Economic

Profit Concept at Deutsche Bank

From Theory to Practise

South Korea, June 2001

Strictly ConfidentialFor Use By Deutsche Bank Consulting Group Only -2-

Contents• Presentation Overview• Deutsche Bank‘s Heritage• Introduction • Deutsche Bank‘s Approach• Deutsche Bank‘s Infrastructure• Issues of Implementation• Deutsche Bank‘s Experience• Conclusion

Contents• Presentation Overview• Deutsche Bank‘s Heritage• Introduction • Deutsche Bank‘s Approach• Deutsche Bank‘s Infrastructure• Issues of Implementation• Deutsche Bank‘s Experience• Conclusion

The purpose of this presentation is to explain the concept of Deutsche Bank’s Economic Profit Concept and its main constituent, RAROC. Deutsche Bank’s basic business decisions are not replaced by RAROC, although our RAROC concept and measurement tools do support management in achieving their objectives.

“Deutsche Bank’s overriding objective is to maximise long term shareholder returns. By focusing on shareholder value we will maintain and improve our ability to prosper in a rapidly intensifying competitive environment.”

“Deutsche Bank’s overriding objective is to maximise long term shareholder returns. By focusing on shareholder value we will maintain and improve our ability to prosper in a rapidly intensifying competitive environment.”

“The introduction of RAROC is a decisive step towards accomplishing value-based management, which marries our internal business objectives at all levels of decision making together with the expectations of our shareholders.”

“The introduction of RAROC is a decisive step towards accomplishing value-based management, which marries our internal business objectives at all levels of decision making together with the expectations of our shareholders.”

Presentation Overview

Deutsche Bank Group Executive BoardDeutsche Bank Group Executive Board

Deutsche Bank Group Executive BoardDeutsche Bank Group Executive Board


Deutsche Bank is one of the Deutsche Bank is one of the leading international financial leading international financial service providers. With more service providers. With more than 98,000 employees and than 98,000 employees and assets exceeding EUR One assets exceeding EUR One Trillion, the bank serves more Trillion, the bank serves more than 12 million customers in 70 than 12 million customers in 70 countries world-wide.countries world-wide.

Deutsche Bank is one of the Deutsche Bank is one of the leading international financial leading international financial service providers. With more service providers. With more than 98,000 employees and than 98,000 employees and assets exceeding EUR One assets exceeding EUR One Trillion, the bank serves more Trillion, the bank serves more than 12 million customers in 70 than 12 million customers in 70 countries world-wide.countries world-wide.

Deutsche Bank has introduced a new group structure (Feb 2001) focusing on 2 customer-oriented risk groups:Corporate and Investment Banking Group Private Clients and Asset Management Group

Customer-oriented Structure Customer-oriented Structure

More Than 130 Years of History More Than 130 Years of History

Credentials - Risk Adjusted Performance Credentials - Risk Adjusted PerformanceWhen Deutsche Bank acquired Bankers Trust in 1999, it inherited the Risk Adjusted Return On Capital (RAROC) concept. Deutsche Bank continues leads the development RAROC in both methodology and tools.

Global Presence Global Presence Germany 51.5 % Rest of Europe 24.2 %America 16.8 %Asia Pacific 7.2 %Africa 0.3 %

Deutsche Bank is represented by more than 1,400 branches in Germany and more than 2,300 worldwide.

Founded in 1870, Deutsche Bank has undergone rapid growth and internationalization to become a global player in the financial services industry.

1989 Acquisition of Morgen Grenfell Group1993 Acquisition of Banco de Madrid S.A. and Banca Popolare di

Lecco SpA.1994 Acquisition of Sharps Pixley Group1995 Acquisition of ITT Commercial Finance, St. Louis (Missouri, USA)1996 Foundation of a fund management company in Singapore

and a subsidiary in Hungary1997 Acquisition of a trust bank in Japan

and an Australian fund management company, Axiom1998 Acquisition of Credit Lyonnais Belgium1999 Acquisition of Bankers Trust

Deutsche Bank’s Heritage


Introduction of Richard Hall

Richard Hall - Bsc(Hons) Mathematics for Business

Deutsche Bank, Head of Global Markets Information Technology (IT) Asia and Head of Global Risk Technology (GRT) Asia

1998-2001 - Deutsche Bank AG, Singapore

• Global Markets IT provides technology support to the Deutsche Bank dealing rooms covering Foreign Exchange, Money Market, OTC Derivatives, Credit Derivatives, Repo and Fixed Income.

• Global Risk Technology provides technology solutions across all the major risk measurement categories - Market, Credit, Liquidity, Operational and Regulatory Risk.

1989-1998 - Bankers Trust Company, London, NY, Tokyo, Hong Kong and Singapore

• Supported all major trading business in various locations plus the Global Risk Management function in London.

Richard Hall - Bsc(Hons) Mathematics for Business

Deutsche Bank, Head of Global Markets Information Technology (IT) Asia and Head of Global Risk Technology (GRT) Asia

1998-2001 - Deutsche Bank AG, Singapore

• Global Markets IT provides technology support to the Deutsche Bank dealing rooms covering Foreign Exchange, Money Market, OTC Derivatives, Credit Derivatives, Repo and Fixed Income.

• Global Risk Technology provides technology solutions across all the major risk measurement categories - Market, Credit, Liquidity, Operational and Regulatory Risk.

1989-1998 - Bankers Trust Company, London, NY, Tokyo, Hong Kong and Singapore

• Supported all major trading business in various locations plus the Global Risk Management function in London.


Capital Markets(Expectations of shareholders)

Economic Profit Concept

Decision Levels

Group

Business divisions / areas

Single customer relationships

Products

Strategic Planning /Evaluation

Capital marketoriented

target setting

Allocation ofResources

Value basedManagement

RAROC

Cost of Capital

Economic Capital

Increase of return

Growth

%

This diagram shows that an increase in the institution’s market value can be achieved either by increasing the profitability of the existing business or from growth. RAROC is the main component of value-based management.

This diagram shows that an increase in the institution’s market value can be achieved either by increasing the profitability of the existing business or from growth. RAROC is the main component of value-based management.

RAROC allows decisions throughout the bank to be compared on a consistent basis in relation to their returns.

RAROC allows decisions throughout the bank to be compared on a consistent basis in relation to their returns.

Economic Capital should be allocated to those customers, products and divisions generating the highest returns.

Economic Capital should be allocated to those customers, products and divisions generating the highest returns.

Introduction to Deutsche Bank’s Economic Profit ConceptValue-based management


Deutsche Bank’s ApproachRAROC aim

Protection of Bank ensuring sufficient capitalisation

Protection of Bank ensuring sufficient capitalisation

Efficient resource allocation to maximise shareholder value

Efficient resource allocation to maximise shareholder value

Which fields of business should

be expanded / shrunk?

Which fields of business should

be expanded / shrunk?

How much capital is needed by DB?How much capital is needed by DB?

• Risk appetite of Deutsche Bank• Regulatory capital requirements• Economic capital requirements reflecting the risk “run” by DB

• Risk appetite of Deutsche Bank• Regulatory capital requirements• Economic capital requirements reflecting the risk “run” by DB

• Efficient use of Economic Capital• Comparison of business activities on a common basis

• Risk vs.. Return for divisions, customer relationships, product sets

• Efficient use of Economic Capital• Comparison of business activities on a common basis

• Risk vs.. Return for divisions, customer relationships, product sets

Risk-based transaction pricing Risk-based transaction pricing How should we

reflect risk in prices?

How should we reflect risk in

prices?

• Competitive pricing• Consider portfolio effects in pricing• Exit from non-profitable business (risk / reward relationship)

• Competitive pricing• Consider portfolio effects in pricing• Exit from non-profitable business (risk / reward relationship)


Deutsche Bank’s ApproachRAROC example - Efficient resource allocation to maximise shareholder value

These examples show how the results for two customers with different credit

qualities can differ depending on how

performance is measured.

Using RAROC as a measure of performance (an economic view), the assessment of a customer can change significantly when compared with a regulatory view such as Return on Equity (ROE).

Using RAROC as a measure of performance (an economic view), the assessment of a customer can change significantly when compared with a regulatory view such as Return on Equity (ROE).

The result is more objective and reliable customer performance evaluation measurement.The result is more objective and reliable customer performance evaluation measurement.


The RAROC ratio can be quoted against any time horizon, however the 'standard' is to quote a one year RAROC ratio.The RAROC ratio can be quoted against any time horizon, however the 'standard' is to quote a one year RAROC ratio.

Deutsche Bank’s Approach

The basic RAROC equation is the ratio between Risk Adjusted Return (RAR) and Economic Capital (EC).

The basic RAROC equation is the ratio between Risk Adjusted Return (RAR) and Economic Capital (EC).

RAROC key elements

Total Revenue minus Total Expenses

• before any risk provisions.

Total Revenue minus Total Expenses

• before any risk provisions.

Expected Loss • Based on a linear mathematical

model of the average expectation of loss within a portfolio.

OR • The “general” and “specific” risk

provisions (sometimes termed as loan loss provisions).

Expected Loss • Based on a linear mathematical

model of the average expectation of loss within a portfolio.

OR • The “general” and “specific” risk

provisions (sometimes termed as loan loss provisions).

The top-line (Risk Adjusted Return):The top-line (Risk Adjusted Return):

Capital Benefit • Overall cost of funding is reduced

from what it would be on a fully-leveraged basis by the cost of funds multiplied by the amount of capital held.

• This is the benefit to the bank from holding economic capital.

Capital Benefit • Overall cost of funding is reduced

from what it would be on a fully-leveraged basis by the cost of funds multiplied by the amount of capital held.

• This is the benefit to the bank from holding economic capital.


Deutsche Bank’s ApproachRAROC in practise

Previously implemented - up to June 2000:RAROC = Risk Adjusted Return /Book Equity Capital

Where,Book Equity Capital = Capital Allocation Factor * Total Economic Capital

Previously implemented - up to June 2000:RAROC = Risk Adjusted Return /Book Equity Capital

Where,Book Equity Capital = Capital Allocation Factor * Total Economic Capital

Where,Capital Allocation Factor = DB Group Share Book Value / DB Group Total Economic Capital

Where,Capital Allocation Factor = DB Group Share Book Value / DB Group Total Economic Capital

Where,Total Economic Capital = Credit Risk Capital, Market Risk Capital and Business Risk Capital

Where,Total Economic Capital = Credit Risk Capital, Market Risk Capital and Business Risk Capital

Book Equity Capital takes the Economic Capital process a step further and links the RAROC process to shareholders expectations by establishing a firm relationship between Risk and Book Equity.

Business Risk was DB’s early approach to address Operational Risk in the RAROC calculation.

The bottom-line (Book Equity Capital):The bottom-line (Book Equity Capital):


Deutsche Bank’s ApproachImpact of BIS on “Total Economic Capital” calculation

Value at Risk Value at Risk Expected / Unexpected Loss

Expected / Unexpected Loss

Losses from single eventsLosses from single events

Losses due to Remaining Volatility

Losses due to Remaining Volatility

Total Economic Capital

Quantified Risk

DB’s Total Economic Capital now comprises of 3 further risk categories (Transfer Risk, Operations Risk & High Impact/Low Frequency Risk) and reflects methodology changes in Market Risk and Credit Risk.

DB’s Total Economic Capital now comprises of 3 further risk categories (Transfer Risk, Operations Risk & High Impact/Low Frequency Risk) and reflects methodology changes in Market Risk and Credit Risk.

Market Risk = Market Risk + Private Equity RiskMarket Risk = Market Risk + Private Equity Risk

Operational Risk = Business Risk + Operations Risk + High Impact/Low Frequency Risk

Operational Risk = Business Risk + Operations Risk + High Impact/Low Frequency Risk

Credit Risk = Counterpart Default Risk + Transfer RiskCredit Risk = Counterpart Default Risk + Transfer Risk


Deutsche Bank’s ApproachRAROC in use

Creating shareholder value has always been DB’s business driver for RAROC

..but in reality the key management focus is first directed towards achieving the acceptable Core Capital Ratio, which is based on Regulatory Capital. Where management of Risk Weighted Assets (RWA) is key

…when DB hits the target Core Capital Ratio, management refocus on creating shareholder value - hence refocus on RAROC

Creating shareholder value has always been DB’s business driver for RAROC

..but in reality the key management focus is first directed towards achieving the acceptable Core Capital Ratio, which is based on Regulatory Capital. Where management of Risk Weighted Assets (RWA) is key

…when DB hits the target Core Capital Ratio, management refocus on creating shareholder value - hence refocus on RAROC

RAROC operates at a portfolio level

…as such, it provides a measure of the ability of a given portfolio to create capital value

RAROC operates at a portfolio level

…as such, it provides a measure of the ability of a given portfolio to create capital value



• At an individual trade level, RAROC has some weaknesses - it can be very sensitive to the input parameters, many of which are estimates

• There is considerable discussion about the most appropriate way to look at RAROC on trade level - e.g. Do you reflect only the marginal costs of doing a trade, or do you allocate a portion of total costs?

• At an individual trade level, RAROC has some weaknesses - it can be very sensitive to the input parameters, many of which are estimates

• There is considerable discussion about the most appropriate way to look at RAROC on trade level - e.g. Do you reflect only the marginal costs of doing a trade, or do you allocate a portion of total costs?

RAROC also operates at a Counterparty and an individual trade level - where it gives an indication of the relative expected profitability

...and is based on an estimate of the incremental economic capital needed to support that trade

…but it is not the only arbiter of whether a trade is acceptable (DB may accept trades that don’t meet hurdle rates, provided they are key to achieving targets on a portfolio)

RAROC also operates at a Counterparty and an individual trade level - where it gives an indication of the relative expected profitability

...and is based on an estimate of the incremental economic capital needed to support that trade

…but it is not the only arbiter of whether a trade is acceptable (DB may accept trades that don’t meet hurdle rates, provided they are key to achieving targets on a portfolio)



Generally, the higher the RAROC, the greater the ability to raise internal capital, and the higher the franchise value

….which helps to boost Market Capitalisation

Generally, the higher the RAROC, the greater the ability to raise internal capital, and the higher the franchise value

….which helps to boost Market Capitalisation

Credit decision making is not binary (yes to “good” risks/no to “bad” risks) - it should be based on Risk/Return decisions

…businesses should be paid more for taking more risk!

…businesses should not accept transactions that destroy capital value - RAROC is a tool that assists in that process

Credit decision making is not binary (yes to “good” risks/no to “bad” risks) - it should be based on Risk/Return decisions

…businesses should be paid more for taking more risk!

…businesses should not accept transactions that destroy capital value - RAROC is a tool that assists in that process


Deutsche Bank’s ApproachRAROC example - Practical advantages in terms of value-based management

Using a RAROC Pricing Tool• Account managers are able to calculate the profitability of any proposed deals after taking

risk into consideration• A new deal is evaluated based on its risk/return relationship - if the original RAROC figure is

unsatisfactory the deal can be restructured as the collateral, term structure and product type are reflected in the RAROC calculation

Using a RAROC Pricing Tool• Account managers are able to calculate the profitability of any proposed deals after taking

risk into consideration• A new deal is evaluated based on its risk/return relationship - if the original RAROC figure is

unsatisfactory the deal can be restructured as the collateral, term structure and product type are reflected in the RAROC calculation

The stair-shaped marking represents the margin, based on credit quality, required to achieve a certain RAROC hurdle rate of 20%

• The rating of B+ requires a margin of 1% to reach a RAROC hurdle of 20%

Incentives for cross-selling activities can be created

The stair-shaped marking represents the margin, based on credit quality, required to achieve a certain RAROC hurdle rate of 20%

• The rating of B+ requires a margin of 1% to reach a RAROC hurdle of 20%

Incentives for cross-selling activities can be created

RAROC calculations are not restricted to corporate banking but can also be used within private banking and investment bankingRAROC calculations are not restricted to corporate banking but can also be used within private banking and investment banking


RAROC reporting Deutsche Bank’s Approach

RAROC: Integrated viewRAROC: Integrated view

RAROC

Expected Loss

Economic Capital

Revenues

Market Risk Operational

Risk Credit Risk

Costs

Business Unit Reports

Special Risk Reports

Risk Controlling,

Business Area Controlling, Credit Risk

Management

Heads of Businesses,

Risk Management,

Group Executive

Board

Group MIS

Group Executive

Board

Segment Reporting

Public

• Transaction/ portfolio level

• Business area specific

•Daily/monthly performance reports

•Daily VaR and monthly control report

• Aggregated Economic Capital, Expected Loss and RAROC

• Economic Capital and RAROC per Business Division and for the Group

Det

ail

Rec

eive

rR

epo

rtin

g L

ine


Global Risk Technology - Example of internal products and services

The aim of Global Risk Technology (GRT) is to provide IT products and services to Global Market Risk Management and Global Risk Controlling.

The systems developed by GRT encompass all major risk categories; Market, Credit, Liquidity, Operational and Regulatory.

The aim of Global Risk Technology (GRT) is to provide IT products and services to Global Market Risk Management and Global Risk Controlling.

The systems developed by GRT encompass all major risk categories; Market, Credit, Liquidity, Operational and Regulatory.

MarketData/OpenData

VALLIB(library)

ARCS2

RPL

PRAMS

DRI

FAME

Bloomberg

JPMwebsite

Reuters

GDDRPL

EIS

CRMS

ETMS

MIS MIS

db Internet

ODMR

VALLIB

* EPC is location specific: London, Tokyo, Hong Kong, New York, Frankfurt and Global

Risk.db.com

LiMAExternalFeeds

ODMRMRE

RMS MTCdb

SummitFNXRegional

BAC Sourceddata

EPC*

GENIE

RAROC/ CAD/Country Risk

GDD1

BOCRE

BOTS

ACE

CDE

CAP

GEDImagine

PUDB

STRUCTURES

LENA LENA

HSG

OPERA

HRComplianceOperations

AuditLegal

CRESEnd user(worldwide)

Deutsche

GRT

External

Key:

Deutsche Bank’s Infrastructure

• Large global team (covering inputs, systems architecture and key MIS)• Due to the global size of Deutsche Bank, GRT has developed a integrated structure (integrated Risk

Controlling web site).

• Large global team (covering inputs, systems architecture and key MIS)• Due to the global size of Deutsche Bank, GRT has developed a integrated structure (integrated Risk

Controlling web site).


Deutsche Bank’s Infrastructure

The Risk, Performance and Limit (RPL) system has been designed to streamline the way in which global risk related information for all Deutsche Bank regional branches and subsidiaries is reported.

Risk related information is reported by recording a statistic and its classification. This allows the system to adapt to changing reporting requirements because the way in which statistics are reported can be controlled by the user.

The Risk, Performance and Limit (RPL) system has been designed to streamline the way in which global risk related information for all Deutsche Bank regional branches and subsidiaries is reported.

Risk related information is reported by recording a statistic and its classification. This allows the system to adapt to changing reporting requirements because the way in which statistics are reported can be controlled by the user.

Global Risk Technology - Example of internal products and services


Front View

Side View

Top View

Issues of Implementation Practical impacts on RAROC

Besides income and costs, RAROC is mainly influenced by two elements:

One: Accurate capture of customer’s credit quality, collateral and size of exposure

• The lower the credit quality, the higher the default rate, the higher the Expected Loss, the larger is the required Economic Capital.

Result - comparatively lower RAROC

• The better the collateralisation, the lower the Expected Loss and the Economic Capital.

Result - comparatively higher RAROC

• The higher the exposure or loan equivalent exposure, the higher the Expected Loss and the required Economic Capital due to higher risk concentration.


Besides income and costs, RAROC is mainly influenced by two elements:

One: Accurate capture of customer’s credit quality, collateral and size of exposure

• The lower the credit quality, the higher the default rate, the higher the Expected Loss, the larger is the required Economic Capital.


• The better the collateralisation, the lower the Expected Loss and the Economic Capital.

Result - comparatively higher RAROC

• The higher the exposure or loan equivalent exposure, the higher the Expected Loss and the required Economic Capital due to higher risk concentration.



Front View

Side View

Top View

Issues of Implementation Practical impacts on RAROC

Two: Portfolio effects

RAROC evaluates any stand-alone deal with respect to the whole portfolio. Here the performance of an individual asset is also dependent on the correlation of that asset’s default rate with that of other assets in the Bank’s portfolio. The model used to assess these correlations should be based on the differentiation of customers in terms of credit quality and macro-economic factors.

• A new commitment in a country or an industry in which the bank has no particular concentration, will attract relatively low Economic Capital

Result: comparatively high RAROC

• A new commitment to a counterparty to which the Bank already has a large exposure, results in a larger risk contribution and a higher Economic Capital requirement.

Result: comparatively low RAROC

Two: Portfolio effects

RAROC evaluates any stand-alone deal with respect to the whole portfolio. Here the performance of an individual asset is also dependent on the correlation of that asset’s default rate with that of other assets in the Bank’s portfolio. The model used to assess these correlations should be based on the differentiation of customers in terms of credit quality and macro-economic factors.

• A new commitment in a country or an industry in which the bank has no particular concentration, will attract relatively low Economic Capital

Result: comparatively high RAROC

• A new commitment to a counterparty to which the Bank already has a large exposure, results in a larger risk contribution and a higher Economic Capital requirement.

Result: comparatively low RAROC


Issues of Implementation Technical impacts on RAROC

Internal modelling• Lack of quality data (standardised data gathering) • Structural change (rigorous mapping of new deals)• Over modelling ie. portfolio is to small, stability a problem• Use of approved risk models, market data source and validation

methodology

Valuation• Multiple future prices (dynamic time period definition)• Consistency in valuation models

Drill-down to support comprehensive management reporting

Input requirements - interface with current systems and customisation of existing MIS

• Data should come from key processing and reporting applications • RAROC figures need to be incorporated into the businesses MIS and

become a key component of the business performance measurement.

Internal modelling• Lack of quality data (standardised data gathering) • Structural change (rigorous mapping of new deals)• Over modelling ie. portfolio is to small, stability a problem• Use of approved risk models, market data source and validation

methodology

Valuation• Multiple future prices (dynamic time period definition)• Consistency in valuation models

Drill-down to support comprehensive management reporting

Input requirements - interface with current systems and customisation of existing MIS

• Data should come from key processing and reporting applications • RAROC figures need to be incorporated into the businesses MIS and

become a key component of the business performance measurement.

Front View

Side View

Top View


Issues of Implementation Technical impacts on RAROC

Data source - ideally data should come from the accounting or back office system

• Most vendors work on the pretence that data comes from a structured system, which is in most cases not the fact, ie. deals recorded and settled on a MS Excel spreadsheet

• Suppression of positions• Other departments doing deals - captures complete set of traded

transactions• Front office using dummy deals• Data integrity of computed fields - Consistency between front office models

and those used to generate and report P&L is critical.

Data source - ideally data should come from the accounting or back office system

• Most vendors work on the pretence that data comes from a structured system, which is in most cases not the fact, ie. deals recorded and settled on a MS Excel spreadsheet

• Suppression of positions• Other departments doing deals - captures complete set of traded

transactions• Front office using dummy deals• Data integrity of computed fields - Consistency between front office models

and those used to generate and report P&L is critical. Front View

Side View

Top View


RPM is the standard GRM tool used to analyse risk-adjusted profitability of commercial banking transactions for financial and non-financial corporate customers.

RPM incorporates a portfolio-dependent approach to the RAROC calculation by considering the risk/return relationship of proposed lending transactions with the global lending portfolio.

RPM handles 3 groups of products encompassing 10 different facility types:

Loan Products: Revolving CreditTerm LoanOverdraftCP Backup (with guarantee function)

Bonds & Guarantees: Standby L/CPerformance BondBid Bond

Trade Finance: Trade L/CBanker’s AcceptanceBills

RPM is the standard GRM tool used to analyse risk-adjusted profitability of commercial banking transactions for financial and non-financial corporate customers.

RPM incorporates a portfolio-dependent approach to the RAROC calculation by considering the risk/return relationship of proposed lending transactions with the global lending portfolio.

RPM handles 3 groups of products encompassing 10 different facility types:

Loan Products: Revolving CreditTerm LoanOverdraftCP Backup (with guarantee function)

Bonds & Guarantees: Standby L/CPerformance BondBid Bond

Trade Finance: Trade L/CBanker’s AcceptanceBills

Risk Pricing Model (RPM)

Deutsche Bank’s Experience Existing GRT Products


Deutsche Bank’s Experience Existing GRT Products

The RTE user can input up to 5 trades, at one time, with the following types of trades currentlybeing covered:

• Vanilla Fixed Rate Agreements• Interest Rate Swaps• Currency Swaps• Caps/Floors• Swaptions• FX Options • FX & Gold Forwards

Future development will incorporate non-vanilla products, commodities and equities.However, exotic trade RAROC can still be calculated if the user supplies their ownexposure profile.

The RTE user can input up to 5 trades, at one time, with the following types of trades currentlybeing covered:

• Vanilla Fixed Rate Agreements• Interest Rate Swaps• Currency Swaps• Caps/Floors• Swaptions• FX Options • FX & Gold Forwards

Future development will incorporate non-vanilla products, commodities and equities.However, exotic trade RAROC can still be calculated if the user supplies their ownexposure profile.

Risk Trade Evaluator (RTE)


Deutsche Bank’s Experience Ongoing initiatives

Research and develop better risk methodologies.

Continuously develop risk management polices and enabling tools.

Enhance internal risk training.

Improve standards for risk information and reporting.

Enhance dialogue with regulators (home and local) to improve the regulatory environment.

Research and develop better risk methodologies.

Continuously develop risk management polices and enabling tools.

Enhance internal risk training.

Improve standards for risk information and reporting.

Enhance dialogue with regulators (home and local) to improve the regulatory environment.

As the world of banking grows more intertwined, the necessity for banks to anticipate and plan for all types of risk becomes increasingly vital.

Moreover, regulators from the Basel Committee on Banking Supervision are focusing on developing capital outlay regulations for operational risk.

Deutsche Bank expects to derive two major benefits from its ongoing investment in operational risk initiatives:

• Improved ability to measure/ model OR losses - which will result in lower regulatory capital charges (Pillar I + II)

• Improved data/ input integrity into the Market and Credit components of our RAROC model

Deutsche Bank expects to derive two major benefits from its ongoing investment in operational risk initiatives:

• Improved ability to measure/ model OR losses - which will result in lower regulatory capital charges (Pillar I + II)

• Improved data/ input integrity into the Market and Credit components of our RAROC model


Deutsche Bank’s Experience Ongoing initiatives

Currently, Economic Capital methodology for Operational Risk is a top-down model approach based on external loss data (tailored to Deutsche Bank needs), which is compliant with the current regulatory debate as well as in line with our general model philosophy.

One of the goals developing the methodology was “sensitivity to managerial action”. In absence of an Deutsche Bank internal loss data history, we introduced a pragmatic but transparent set of incentive factors which influence the OR Capital charge of a business division. Max. 20 % of the charge could be reduced by applying the incentive factors.

One of the goals developing the methodology was “sensitivity to managerial action”. In absence of an Deutsche Bank internal loss data history, we introduced a pragmatic but transparent set of incentive factors which influence the OR Capital charge of a business division. Max. 20 % of the charge could be reduced by applying the incentive factors.


• Understand your profits.

• Strategic reallocation of Economic Capital in order to support value-based management throughout the bank.

• Change Management - RAROC fundamentally changes the bank’s risk culture.

• Implementation requires strong support from management throughout the organisation and clearly defined accountability.

• Quality of data underpins the effectiveness of all value-based management - RAROC initiatives.

• Enhances the ability to target customers and manage the bank’s relationship in the most beneficial manner.

• Enables the business to view the “risk and reward” by transaction, product or business division.

• Demonstrate the importance of risk management to the overall profitability of the bank - abolish the “policeman” perception.

• Risk management is a continuous evolution process.

• Understand your profits.

• Strategic reallocation of Economic Capital in order to support value-based management throughout the bank.

• Change Management - RAROC fundamentally changes the bank’s risk culture.

• Implementation requires strong support from management throughout the organisation and clearly defined accountability.

• Quality of data underpins the effectiveness of all value-based management - RAROC initiatives.

• Enhances the ability to target customers and manage the bank’s relationship in the most beneficial manner.

• Enables the business to view the “risk and reward” by transaction, product or business division.

• Demonstrate the importance of risk management to the overall profitability of the bank - abolish the “policeman” perception.

• Risk management is a continuous evolution process.

Conclusion

[email protected] [email protected]

Risk Adjusted Performance Measurement - the Economic Profit Concept at Deutsche Bank From Theory to...

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