Stress Testing and Risk Integration in Banks: University of Passau
Stress Testing and Risk Integration in Banks: University of Passau
Stress Testing and Risk Integration in Banks: University of Passau
University of Passau
Tiziano Bellini
tiziano.bellini@unipr.it
EY London
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Outline Framework
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Outline Framework
Toolkit
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Outline Framework
Framework Outline
The following key areas are covered to achieve book’s goals:
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Outline Agenda
Agenda
I Introduction
I Stress Testing
I Concluding Remarks
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Introduction Agenda
Agenda
I Introduction
I Regulatory Responses
I Capital, leverage and liquidity ratios
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Introduction What Went Wrong
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Introduction What Went Wrong
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Introduction Regulatory Responses
Regulatory Capital
Capital Ratio = . (1)
RWA
Capital Exposure
Leverage Ratio = ≥ 3.00%. (2)
Exposure Measure
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Introduction Regulatory Responses
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Introduction Regulatory Responses
Liquidity
1
Under consultation until 2018.
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Introduction Regulatory Responses
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Introduction Book Structure at a Glance
Book Structure
1. A key step in the stress testing journey is to highlight the
connection between the overall economy and a given bank.
2. A bank can be explored by means of its asset and liability
structure with focus on: trading book, banking book, liabilities
and own funds.
3. Each of these areas affects capital, leverage and liquidity
ratios. They also are the key ingredients of risk integration and
reverse stress testing processes.
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Introduction Book Structure at a Glance
Chapters’ Organisation
I A matrix scheme has been used by considering asset and
liability together with key risk management metrics as journey’s
cornerstones.
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Macroeconomic Transmission Mechanics Agenda
Agenda
I Bank Alpha
I Regulatory Capital
I Risk Weighted Assets (RWAs)
I Leverage and Liquidity
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Macroeconomic Transmission Mechanics Macroeconomic Modelling
Conditional Forecast
I The conditional VAR can intuitively be represented as follows in a
VAR(1) framework
xt = c + Φ1 xt−1 + t , (7)
therefore
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Macroeconomic Transmission Mechanics Bank Alpha
Assets Liabilities
Cash resources 8.00 Deposits 70.00
Securities 14.00 Others 17.00
Loans 70.00 Subordinated debts 4.00
Others 8.00 Non controlling interests 2.00
Shareholder equity 7.00
Total assets 100.00 Total liabilities 100.00
Table: Bank Alpha’s balance sheet in t0 ($ billions).
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Macroeconomic Transmission Mechanics Bank Alpha
Regulatory Capital t0
Common equity tier 1 (CET1) 4.44
Additional Tier 1 1.00
Tier 1 5.44
Tier 2 6.00
Total capital 11.44
Table: Bank Alpha’s regulatory capital in t0 ($ billions).
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Macroeconomic Transmission Mechanics Bank Alpha
t0
Leverage ratio 5.53 %
LCR 104.00 %
NSFR 88.25 %
Table: Bank Alpha’s leverage and liquidity ratios.
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Macroeconomic Transmission Mechanics Bank Alpha
0.07 0.04
0.06
0.02
0.05
0
0.04
-0.02
0.03
US
-0.04 China DA
0.02 US Unemployment Euro
US rLT Japan
0.01 -0.06
US rST UK
0 -0.08
0 2 4 6 8 10 12 0 2 4 6 8 10 12
102
0.02
100
0.01
98
0 96
94
-0.01 US
China DA China DA
92
Euro Euro
-0.02 Japan Japan
90
UK UK
-0.03 88
0 2 4 6 8 10 12 0 2 4 6 8 10 12
Time Time
Agenda
I Stress Testing
I RWA Stress Testing
I Market Risk RWA
I Credit Risk RWA
I Operational Risk RWA
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Stress Testing RWA Stress Testing
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Stress Testing RWA Stress Testing
I The VaR at level (1 − α), is computed as the smallest loss (`) such
that
VaR(1−α) = inf P(Loss∆R > `) ≤ α. (11)
`
I The variance-covariance approach is usually adopted in portfolios
with linear pay-offs where returns have variance w 0 Σw (w is the
vector of weights and Σ is the variance covariance matrix of
returns).
I The following equation summarizes VaR by relying on the usual
assumption to multiply the 1-day VaR times the square root of t
p √
VaR(1−α),t = Φ−1 (α) w 0 Σw t. (12)
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Stress Testing RWA Stress Testing
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Stress Testing RWA Stress Testing
Figure: Loss distribution. Expected loss (EL) vs. unexpected loss (UL).
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Stress Testing RWA Stress Testing
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Stress Testing Balance Sheet Projection
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Stress Testing Balance Sheet Projection
Ak ,t = βk ,0 + βk ,1 xt + . . . + βk ,p xp,t + k ,t , (28)
)0
whereby β k = (βk ,1 , . . . , βk ,p is the vector of coefficients fitted
against the vector of macroeconomic variables
xt = (x1,t , . . . , xp,t )0 . Other credit life cycle components are derived
to get the overall balance sheet evolution.
I The trading book may be projected as follows
(
TBt+h = TBt + ∆TBh ,
(29)
∆TBh = f (RAt , xh,∆ ),
where TBt is the trading book volume at time t, while ∆TBh is its
variation overh. This variation is linked to the risk appetite RAt and
macroeconomic conditions xh,∆ .
I A similar approach may be followed for liabilities.
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Stress Testing Balance Sheet Projection
2
Minimum threshold 3%.
3
Minimum threshold 100%.
4
Minimum threshold 100%, consultation period until 2018.
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Risk Integration and Reverse Stress Testing Agenda
Agenda
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Risk Integration and Reverse Stress Testing Risk Integration
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Risk Integration and Reverse Stress Testing Risk Integration
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Risk Integration and Reverse Stress Testing Risk Integration
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Risk Integration and Reverse Stress Testing Risk Integration
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Risk Integration and Reverse Stress Testing Risk Integration
Bottom-up |Workflow
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Risk Integration and Reverse Stress Testing Risk Integration
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Risk Integration and Reverse Stress Testing Risk Integration
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Risk Integration and Reverse Stress Testing Reverse Stress Testing
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Risk Integration and Reverse Stress Testing Reverse Stress Testing
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Risk Integration and Reverse Stress Testing Reverse Stress Testing
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Risk Integration and Reverse Stress Testing Reverse Stress Testing
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Concluding Remarks Agenda
Agenda
I Concluding Remarks
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Concluding Remarks What’s Next
Concluding Remarks
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