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Market Risk
Corporation Bank
Structure
Introduction
Broad Principles for RBI Approval
Qualitative Criteria for IMA Approval
Quantitative Criteria
Risk Measurement
Back Testing
Stress Testing
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
Scope of IMA
Only Held for trading will come under IMA
AFS to continue under SMM, as markets are illiquid and market prices may not be
available
If other group level entities are not ready, IMA for parent, and those entities which
are ready, and SMM for others
Insignificant positions, minor currencies, negligible business areas, etc. can be
under SMM
Expected to follow IMA to all market risk positions and entities in the future
Trading Book risk covers
Interest rate-related instruments and equities in trading book
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
Risk Management models in use far more advanced than rigid rules
Banks can use their own VaR models as basis for capital requirement for
Market Risk
VaR is a robust Risk Measurement and Management Practice
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
Internal Audit
Unit
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
Model Development
Unit
Daily reports for Risk Unit to be reviewed by Senior Management in order to take appropriate
remedial action, if required
Banks risk measurement system must be well documented to describe the basic principles of
risk management system and to provide empirical techniques used to measure market risk.
Ongoing, updated Dossier - to keep a record of the details of the model and of the changes /
refinements,
Can be built by references and links to other policies, operating manuals
Independent Risk Control Unit responsible for design and implementation of Banks risk
management systems
Banks Internal Risk Measurement Model must be integrated into Management decisions
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
ensure that the vendor model is appropriate for measuring the market risk of the bank,
given the nature of the portfolio and the capabilities of the staff; and
have clearly described strategies for regularly reviewing the performance of the vendor
model.
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
ensuring that the current systems setup is capable of supporting the models; all
changes made to the models being used, or to the modelling process, should be
validated and approved;
maintaining previous versions of the model being altered; and
Ensuring models are subjected to change-control procedures, so that computer
codes cannot be changed except by authorized staff.
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
10
Internal Audit
Purpose of Internal Audit Team is to ensure:
The adequacy of the documentation of risk management system and process;
The organization and functioning of the risk control unit;
The approval process for risk pricing models and valuation systems used by front
and back-office personnel;
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
11
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
12
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
13
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
14
RBI assessment
RBI performs an assessment based on the following parameters:
Accuracy of documentation
Model scope
Qualitative review
Technological environment and information integrity
Quantitative review
Model monitoring (any modification proposed need prior intimation and approval from RBI)
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
15
Normal VAR
Stressed VAR (for positions subject to interest rate specific-risk
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
16
The value at risk (VAR) of a portfolio is the loss in value in the portfolio that can be expected
over a given period of time (e.g., 1-Day) with a probability not exceeding a given number (e.g.,
5%)
Probability (Portfolio Loss VAR) = K
K = Given Probability
Confidence level
Loss Amount
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
17
Computed daily
Horizon of 10 Trading days Can use daily VAR and scale to 10 days
99% confidence level
Observation period at least 1 year historical data
Update data sets at least quarterly
Can use any type of model - variance-covariance matrices, historical simulations, or
Monte Carlo simulations.
Portfolio VaR for the bank has been provided in the attached PDF
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
18
The Approach
5%
-10MM
Possible Profit/Loss
Strengths
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
19
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
20
The model inputs for the stressed VaR should be calibrated to historical data
from a continuous 12-month period of significant financial stress relevant to the
banks portfolio
The said period of stress will be approved by the RBI as part of its approvalfor
the IMA model submitted by the bank and would be regularly reviewed.
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
21
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
22
Capital computation
Total Market Risk Capital is sum of :
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
23
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
24
Stressed VAR
Mc Factor Range
3 -4
Mc How used
RBI
RBI
0-1
0-1
Pc How used.
Pc Who determines
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
3-4
25
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
26
Back Testing
Statistical testing that consist of checking whether actual trading losses are in
line with the VAR forecasts
The Basel back testing framework consists in recording daily exception of the 99% VAR
over the last year
Even though capital requirements are based on 10 days VAR, back testing uses a daily
interval, which entails more observations
A bank should also report to the RBI the results of their back-testing exercise every
quarter before the last day of the month. In addition to exceptions, report to include:
The banks systems are not simply capturing the risk of the positions themselves.
Model volatilities and/or correlations were calculated incorrectly
Models accuracy could be improved
Bad Luck or market moved in unanticipated manner
Loss due to intra-day trading
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
27
Back Testing
2014 KPMG, an Indian Partnership and a member firm of the KPMG network
of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
28