Basel III, Risk Assessment and Stress Testing

Understanding The Role Of Regulatory Bank Capital

        Overview of financial statements of banks – accounting principles
        Composition of the balance sheet – types of assets and liabilities
        Understanding the key elements of the P&L - statement of income
        Review of the distinction between the banking book and the trading book
        The equity capital of financial Institutions
        Illustration of the contrast between liquidity and solvency issues
        Distinguish between going concern and gone concern capital
        Explanation of bail-in able capital
        Accounting and regulatory definitions for own funds
        Prudential filters and revaluation reserves, AOCI
        Treatment of goodwill, intangibles, deferred tax assets
        Treatment of securitizations and off-balance sheet exposures
    

Requirements for Qualifying Capital under Basel III

        Definitions of Regulatory Capital – Core Tier 1, Tier 2
        Core Tier 1 – equity capital and disclosed reserves
        Supplementary Capital – Tier 2 – subject to discretion of supervisor/central bank
        Hybrid capital – Contingent Capital Instruments (CoCo’s)
        Subordinated debt - bail-in instruments
        Short-term subordinated debt covering market risk (Tier 3)
        Loss absorbency requirements
        Deductions from capital – goodwill and subsidiaries
        Supervisory discretion over cross holdings of other banks

Basel Treatment of Market Risk

        Value at Risk (VaR) – rationale, theory and methods of calculation
        Limitations of parametric VaR
        What about tail risk – does VaR capture this adequately?
        Expected Shortfall and FRTB
        Risk weightings for market risk
        Standardized approach
        Interest rate risk in both the trading book and banking book
        Overview of Internal Models Approach (IMA)
        Impact of market risk on instruments in the trading book
        Volatility and market stress
        Incremental Risk Charge
        Off Balance Sheet items

Operational Risk under Basel

        Definition of Operational Risk introduced into the Basel II framework
        The life cycle of Operational Risk
        Basel measurement approaches to be phased out by 2023:
            Basic Indicator
            Standard Approach
            Advanced Measurement Approaches
        Revised Standardized Approach replaces previous three methods
        Risk weightings under each approach
        Rogue trading – severity of losses
        Scenario generation – KRI’s, management involvement in adverse scenario modelling
        Quantifying the exposure and severity of “outliers” and tail risk
        Loss Distribution Approach (LDA) and Scenario Based Analysis (SBA)
        Application of VaR techniques to operational risk (Op VaR)
        Loss identification – measurement, management, monitoring, reporting
        Integrating operational risk management into the organizational risk management framework

Alternatives to using external credit ratings

        Developing internal scoring models for assessing corporate loan exposures
        Contrast of developed and emerging economy approaches to credit risk assessment

Credit Concentration Risk and Large Exposures

        Concentration risk - not adequately captured under the Pillar One approaches
        Brief summary of the Supervisory Review and Evaluation Process (SREP)
        Treatment of Concentration Risk within the Pillar II ICAAP framework
        Identifying sectoral concentration risk – general principles
        Quantifying concentration risk in GCC

Modeling and Stress Testing

        Explanation of the techniques for conducting stress tests
        Back testing using historical returns
        Scenario generation - stress testing using hypothetical returns
        Sizes of historical samples – are they sufficiently large to include wide variety of conditions?
        Danger of optimizing risk management parameters - over-fitting to the historical data
        Modelling methods – contingency scenarios
        Limitations of normal distribution as basis for probabilistic modeling
        Quantifying the exposure and severity of “outliers” and tail risk
        Explanation of Stressed Expected Shortfall methods

Drivers of Counter-party Risk (CCR)

        Separating market risk impact on trading positions from CCR
        Pricing counterparty risk – use of spreads, ratings
        Probability of Default (PD) – Estimation of PD and Exposure at Default (EAD)
        Expected Positive Exposure (EPE)
        Loss Given Default (LGD) and recovery rates
        Counterparty risk in credit default swaps
        Counterparty risk in interest rate swaps
        Experience of AIG and mono-lines insurance companies in financial crisis
        The role of a central clearing house
        Stress analysis and randomized stress scenarios
        Market factors which drive counter-party credit deterioration

Credit Value Adjustment (CVA) and collateral

        Definition of Credit Value Adjustment (CVA)
        Defining credit exposure in relation to market risk impact on derivatives
        Expected positive exposure and worst case exposure
        Nature of collateralization – ISDA treatment
        Benefits of effective collateral management
        Impact of netting on CVA
        Impact of collateral on CVA
        Hedging and credit default swaps
        Eligible hedging instruments
        Bilateral counterparty risk and collateral
        Over-collateralized positions and risk of counterparty default

Liquidity Coverage Ratio (LCR)

        Explanation of Liquidity Coverage Ratio (LCR)
        Criteria for inclusion as High Quality Liquid Assets (HQLA)
        Categories of HQLA – Level 1, Levels 2A and 2B
        Net Stable Funding Ratio (NSFR)
        Explanation of available funding (ASF) versus required funding (RSF)
        Weighting factors for ASF and RSF

Impact of Basel III on the Business Model of Banking

        Impact of the Basel III LCR on balance sheet exposures to non HQLA assets
        Hoarding of Level 1 HQLA assets
        Unintended consequences for macro liquidity from Basel III regulations
        Linkage of sovereign and domestic banking credit quality
        Decreased inventories of corporate bonds being held by primary dealers
        Requirements for unrealized losses with AFS securities to be deducted from CET1
        Explanation of Contingent Capital instruments (CoCo’s)
        Role of CoCo’s as contributor to AT1 for capital adequacy purposes
        Brief history of CoCo’s and inability to see the consequences from conversion
        Sovereign wealth fund exposure to CoCo’s – elevated liquidations of SWF assets
        Possible suspensions/reductions of coupon payments of CoCo’s
        Collateral netting across CCP’s
        Shortage of collateral – implications, effect on bank’s ROE
        Impact of TLAC on G-SIB banks

Implementation and Reporting Systems for Basel Compliance

        Efficacy of the monitoring and reporting mechanisms within banks and how they interface with overall risk management
        Avoiding silos
        Accounting, surveillance, IT systems and data storage back-up systems
        Monitoring of controls – quality and integrity of the procedures
        Development of contingency scenarios
        Role of the Chief Risk Officer
        Role of the Internal Auditor
        Developing dashboards for KRI’s for credit, market and operational risk