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CRD 3 and beyond
How are you left?
Simon Hills
British Bankers Association
British BankersтАЩ Association
Evolution of regulatory capital for the trading book
тАвBasel 1 - 8% capital against RWAs (1992)
тАвCAD 1 and basic market risk approaches (1993)
тАвBasel Market Risk amendments (1997)
oMarket risk on debt, FX, equities options & commodities in Trading book
oInternal VaR models
тАвBasel II new capital adequacy framework (2007 in EU)
oIDRC (in Europe)
тАвBasel trading book package = CRD 3
1 January 2011
o Stressed VaR, Incremental Risk Charge, standardised charges for securitisation, correlation
trading models
British BankersтАЩ Association
The construct
тАв
тАв
тАв
Regulatory split of assets between banking book and trading book
Banking book unless you can convince regulator otherwise
Trading book capital treatment if:
тАЬA trading book consists of positions in financial instruments and commodities held either
with trading intent or in order to hedge other elements of the trading book. To be eligible
for trading book capital treatment, financial instruments must either be free of any
restrictive covenants on their tradability or able to be hedged completely. In addition,
positions should be frequently and accurately valued, and the portfolio should be actively
managed.тАЭ
тАв
Trading intent?
тАЬPositions held with trading intent are those held intentionally for short-term resale and/or
with the intent of benefiting from actual or expected short-term price movements or to lock
in arbitrage profits, and may include for example proprietary positions, positions arising
from client servicing (e.g. matched principal broking) and market making.тАЭ
British BankersтАЩ Association
Banking / trading book boundary
тАвFX & commodity position тАУ uniform (market risk) capital requirements
whether in trading book or banking book
тАвEquities/credit: trading / banking book boundary determines whether
capital held for market risk or credit risk
тАвBanking book (credit risk) long only regime, 1 year 99.9% calibration
тАвTrading book, long + short (portfolio approach) 10 99% calibration
British BankersтАЩ Association
What you do now.............
тАвFair valuation of positions тАУ accounting / regulatory definition
тАвProfits/losses taken immediately
o Losses reduce Tier 1 capital immediately
o Unrealised тАШverifiedтАЩ profits can be recognised as Tier 1
тАвHedging recognition depends on standard rules or modelled approach
тАвMarket risk primary focus of regulatory capital
British BankersтАЩ Association
.............and the future?
тАЬCapital required against trading book activities should be increased
significantly (e.g. several times) and a fundamental review of the
market risk capital regime (e.g. reliance on VAR measures for
regulatory purposes) should be launchedтАЭ
тАЬThe BCBS should follow up its current proposals for short-term
reform of trading book capital with a fundamental review, to include
the role of VaR measures and the boundary between the trading
and banking booksтАЭ
Turner Review
March 2009
British BankersтАЩ Association
.............and the future?
тАвCurrent regulatory boundary means some risks not properly captured:
o Credit risk in trading book
o No market risk charge for fair valued assets in banking book
тАвIntent vs. trading feasibility
тАвWhat about market liquidity risks?
тАвIs ten day capital horizon appropriate?
тАвAre counterparty credit risk requirements enough?
oCharge for Credit Valuation Adjustment??
тАвSo capital requirements too low??
British BankersтАЩ Association
The problems
Risk management & modelling
o Does VaR modelling for regulatory purposes capture tail risk?
o Modelled capital requirements very cyclical
o Complexity and modelling donтАЩt mix?
Valuing traded assets
o Get it right тАУ it is the building block
o Accounting Point in Time vs. forward looking regulatory requirement
o Existing prudent valuation requirements тАУ are they enough?
British BankersтАЩ Association
A regulatory response so far тАУ specific
measures - The Proposal
July 2009 Basel Committee (CRD 3) package for implementation by January 2011
Measure
Stressed VAR
Incremental risk
charge (IRC)
Traded
securitisation
products
Additional
Additional capital
capital charge
charge based
based on
on
stressed
calibration
of
VAR
model
stressed calibration of VAR model
inputs
inputs
Impact
Increaseinincapital
capital
тАв тАв Increase
requirementfor
formodelled
modelled
requirement
positions
positions
Reductionininrelative
relativecyclicality
cyclicality
тАв тАв Reduction
VARcapital
capitalrequirement
requirement
ofofVAR
Firms must capture incremental (to
VAR) credit default and migration risk
on modelled credit products in the
trading book
тАв Improves risk capture on
traded credit positions
тАв Additional modelling standards for
portfolioтАЭ standards for
тАв тАЬcorrelation
Additional modelling
тАЬcorrelation portfolioтАЭ
тАв Application of banking book credit
weights to
netbook credit
тАв risk
Application
of other
banking
securitisation
positions
risk weights to
other net
securitisation positions
тАвтАв Improves
Improves risk
risk capture
capture for
for
correlation
correlation portfolio
portfolio
тАв Calibrated to one year 99.9%
level
тАвтАв Reduces
Reduces scope
scope for
for regulatory
regulatory
capitalon
arbitrage
capital arbitrage
on
securitisation
products
securitisation
products
тАвтАв Expected
Expected to
to lead
lead to
to significant
significant
increase inincrease
capital in capital
requirements
requirements
British BankersтАЩ Association
Challenges ahead
Stressed VAR
тАв Doubles (at least) capital requirement
тАв I year period
тАв Implemented across multiple levels of portfolio
тАв Ability to perform 10 day VaR rather than scaling up
тАв How to combine VaR and stress testing
тАв Data for stressed time series?
тАв Duplicate models for risk management and regulatory capital
British BankersтАЩ Association
Challenges ahead
Credit Valuation Adjustment
тАв Concept OK
тАв Bond equivalent approach doesn't reflect economic hedges
тАв Needs close alignment of many internal functions
тАв Industry believes market implied approach better
тАв 2nd consultation for CVA??
British BankersтАЩ Association
Challenges ahead
тАв Overall calibration тАУ QIS results awaited
тАв CCPs - reduced spreads?
тАв Leverage ratio
o Ignores netting
o Nominal not regulatory equivalent numbers
o Impact on strategy and appetite
тАв
Unrated re-securitisations = 1250% weighting or deduction
British BankersтАЩ Association
What to do ?
тАв
тАв
тАв
тАв
тАв
тАв
Risk and finance data integration
Coordination of market risk and regulatory reporting
Required data histories for long term analysis
Model validation quality тАУ internal and for FSA
Identification of re-securitisations
Review trading book governance тАУ intent vs. feasibility
British BankersтАЩ Association
Summary
тАв
тАв
тАв
тАв
тАв
тАв
Lots changing
Much more capital
Risk of double counting
Impact on business models
Will risk be managed better?
Lobby now
British BankersтАЩ Association
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