Sensitivity to Market Risk · Sensitivity to Market Risk Bank Analysis and Examination School ....
Transcript of Sensitivity to Market Risk · Sensitivity to Market Risk Bank Analysis and Examination School ....
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Sensitivity to Market Risk
Bank Analysis and Examination School
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Sensitivity to Market Risk Objectives
Background Review Four kinds of interest rate risk Short-term and long-term views Risk measurement models Regulatory guidance
Assign the “S” rating
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Market Risk Background
SR 93-69: “Risk Management and Internal Controls of Trading Activities”
SR 95-17: “Risk Management and Internal
Controls of Non Trading Activities” SR 95-51: “Rating Risk Management
Processes and Internal Controls”
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Market Risk Background
SR 96-38 “Uniform Financial Institutions Rating System”
“Sensitivity to Market Risk” rating Rating Based On: Level of exposure to market risk Quality of risk management Nature and complexity of activities
SR 97-4 “...Common Questions...”
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Sensitivity to Market Risk
Principal form of market risk affecting banks is Interest Rate Risk
The possibility that changes in interest rates will adversely affect the banking organization.
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Four Kinds of Interest Rate Risk
Interest rate risk is the principal form of market risk for banks. Four sources include:
Mismatch risk Basis risk Options risk Yield curve risk
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Interest Rate Risk: Two Views
Short-term: Effect on net interest income. Earnings-at-Risk Gap analysis Net interest income simulation
Long-term: Effect on the net present value of future earnings.
Economic Value of Equity-at-Risk Duration of equity analysis Present value scenario analysis
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GAP ANALYSIS
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Gap Analysis
Rate-sensitive assets (RSA) and liabilities (RSL) are slotted according to repricing date. RSL are subtracted from RSA to yield
the “gap”. The gap number can be either positive
or negative.
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Estimate Earnings-at-Risk Using Gap Analysis
EAR = (Rate change) x (Cumulative gap) = (1%) x ($4,250 MM) = $42.5 MM
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Gap Analysis
Assumptions: Time bucket selection Slotting assets and liabilities Slotting non-maturity items Static balance sheet Parallel changes in the yield curve
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Gap Analysis
Weaknesses: Short-term focus Does not capture basis, option, or yield
curve risk Inappropriate for complex balance
sheets
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NET INTEREST INCOME SIMULATION
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Net Interest Income Simulation
Models calculate expected income using: Various rate scenarios Projected balances for assets and liabilities Other assumptions
Rate changes should be large enough to reveal sources of risk Complexity of the model can vary
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Net Interest Income Simulation
Advantages: Projects net interest income Addresses assumptions Can capture mismatch, basis, and
option risk Can be used for strategic planning and
“what if?” scenarios
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Net Interest Income Simulation
Weaknesses: Short-term focus (12 - 24 months) Only captures option risk when options
are “in the money” Difficult to project far into the future Results can be shaded by management Apparent precision can be misleading
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ECONOMIC VALUE-AT-RISK
MODELS
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Economic Value-at-Risk Models
Duration of Equity Analysis and Present Value Scenario Analysis measure the economic-value-of-equity at risk to changes in rates.
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Duration of Equity Analysis
The weighted average duration of assets, less the weighted average duration of liabilities, plus the net weighted average duration of off-balance sheet items, divided by equity. DE = DA(A) - DL(L) + DOBS (E)
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Duration of Equity Analysis
Duration of equity calculation can be used as a forecast of the sensitivity of the economic value of equity to a change in rates in the same way as the duration of a bond can be used to predict its price.
Change in EVE = (-DE) x (% Change in Rates)
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Duration of Equity Analysis
Weaknesses: Only accurate for small rate changes. Duration of different instruments will
change at different rates over time. Does not capture basis or option risk.
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Present Value Scenario
Analysis
Like the duration of equity model except: Calculates current net present value of each asset,
liability, and off-balance sheet item Then recalculates the net present value of each
instrument for a given rate scenario Finally, the net present value of equity is calculated:
PVE = PVA - PVL + PVOBS
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Present Value Scenario
Analysis
Advantages: Long-term measure of interest rate risk Captures mismatch, basis, yield curve,
and option risk Accurate even for larger rate change
scenarios (200 b.p.)
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Risk Measurement Models Review
QUESTIONS? Models?
Assumptions?
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Assigning the “S” Rating
Component reflects: Level of exposure to market risk Quality of market risk management Nature and complexity of activities
Evaluated in relation to the adequacy of
the institution’s capital and earnings
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Level of Exposure Assigning the “S” Rating
Cumulative Gap As % of total assets or capital
Earnings at Risk % change for given shift in interest rates
Economic Value of Equity at Risk Change (as % of assets) for given shift in
interest rates
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Quality of Risk Management Assigning the “S” Rating
Management’s ability to identify, measure, monitor, and control market risk Board oversight Policies and procedures MIS: assumptions, adequacy Internal controls and audit Credit, liquidity, operational,
legal, and reputational risk
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Nature & Complexity of Activities Assigning the “S” Rating
Nontrading activities Hedging Trading activities
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Nontrading Activities Assigning the “S” Rating
Factors to Consider: Long-term fixed rate assets Complex investments Options Funding sources Nonmaturity deposits Mortgage banking and servicing assets
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Hedging Activities Assigning the “S” Rating
Instruments to Consider: Forward based contracts Option contracts Option-based agreements Short sales
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Trading Activities Assigning the “S” Rating
Factors to Consider: Types of trading Market risk exposure Market risk limits
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“S” Rating Write-up Guidelines
Conclusion with support and a rating Quantity of risk Quality of oversight, MIS, and controls Recommendations
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QUESTIONS?