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IMA approach
Basel Accord
• Capital requirement were simplistic and rigid – but did not reflect
underlying economic risks of banks / FIs
• Assumes that Worst Loss will hit all portfolios at the same time
IMA recognises –
• Regular Back-Testing
• Stress Testing
Time
Market Risk Amendment
Frequency of loss
Expected Unexpected loss Stress
loss loss
0 Amount of loss
Supporting Factors for Risk Management
1 Involve of
the board of directors
and high level management
4 2
Effective Risk Formulate risk
Set up risk
Management management policies
management system
and procedures
Supervisory objectives
Policy Governance
Risk Strategy Accountability
Risk Appetite
Internalising
Risk Managem ent Models Reporting
Projection & Analysis Models
Annual: planning, forecasting, budgeting Risk Monitoring
Risk Maps Risk Analysis
Economic Capital Pricing, capital management Risk Reporting
Sensitivity Measures & Analysis
External Factors
financial markets, competition, tax & regulation
Impact & Benefits
• Best practice risk and capital management
– In particular:
• Risk management - processes and controls
• Capital management - eligible capital and quality of capital
• Improved market perception: enhanced reputation for
risk management
• The risk measurement system should model the yield curve using one
of a number of generally accepted approaches
• For exchange rates (which may include gold), the risk measurement
system should incorporate risk factors corresponding to the individual
foreign currencies in which the bank’s positions are denominated
• Banks should update their data sets no less frequently than once every three months and should also
reassess them whenever market prices are subject to material changes
• No particular type of model is prescribed – should captures all the material risks run by the bank
• Banks will have discretion to recognise empirical correlations within broad risk categories
• Banks’ models must accurately capture the unique risks associated with options within each of the
broad risk categories
• Each bank must meet, on a daily basis, a capital requirement expressed as the higher of
(i) its previous day’s value-at-risk number measured according to the parameters specified in this
section and
(ii) an average of the daily value-at-risk measures on each of the preceding sixty business days,
multiplied by a multiplication factor
• multiplication factor will be set by supervisory authorities on the basis of their assessment of the quality
of the bank’s risk management system, subject to an absolute minimum of 3.
• Banks using models will also be subject to a capital charge to cover specific risk (as defined under the
standardised approach for market risk) of interest rate related instruments and equity securities
Stress Testing
• Stress testing to identify events or influences that could greatly
impact banks is a key component of a bank’s assessment of its
capital position
• Guidelines to compute
– Interest rates risk
– Exchange risk
– Equity risk
– Commodity risk
• Specific/Idiosyncratic risk
The Standardized Approach - Market Interest Rate Risk
Where,
– for active trading in commodity, the model should account for for
movements in the spot plus convenient yields
Tools
– Scenarios Analysis
– Stressing Models
– Policy Response
Stress Testing - Scenarios Analysis
• Evaluating the portfolios
– under various states of the world
– evaluating the impact
• changing evaluation models
• volatilities and correlations
• Scenarios requiring no simulations
– analyzing large past losses
• Scenarios requiring simulations
– running simulations of the current portfolio subject to
large historical shocks e.g. 1987 crash, etc ...
• Bank specific scenario
– driven by the current position of the bank rather than
historical simulation
• Much more subjective than VAR
• Can help to identify undetected weakness in the bank's
portfolio
Back testing
• Stress Testing
– A process to identify and manage situations that
could cause extraordinary losses
– Scenarios requiring no simulation
– Scenarios requiring a simulation
– Bank-Specific scenarios
Basel Market Risk Charges
• Back testing
– A statistical testing framework that consists of
checking whether actual trading losses are in line
with VAR forecasts
– Exceptions
– The Penalty Zones
– Basic integrity of the model
– Deficient model accuracy
– Intraday trading
– Bad luck
The Internal Model Approach (IMA)
Tools
– Scenarios Analysis
– Stressing Models
– Policy Response
Stress Testing - Scenarios Analysis
• Evaluating the portfolios
– under various states of the world
– evaluating the impact
• changing evaluation models
• volatilities and correlations
• Stress Testing
– A process to identify and manage situations
that could cause extraordinary losses
– Scenarios requiring no simulation
– Scenarios requiring a simulation
– Bank-Specific scenarios
Basel Market Risk Charges
• Back testing
– A statistical testing framework that consists of
checking whether actual trading losses are in
line with VAR forecasts
– Exceptions
– The Penalty Zones
– Basic integrity of the model
– Deficient model accuracy
– Intraday trading
– Bad luck
Internal Model Approach - VaR
Qualitative Requirements :