Basel III, Risk Assessment and Stress Testing

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BASA Facilitator

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Accounting and Finance

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  • 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
    • Revaluation reserves - limitations
    •  Hybrid capital – equity-like e.g. perpetual preferred shares
    • Subordinated debt instruments – criteria and restrictions
    • 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?
    • 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:
      • Basic Indicator
      • Standard Approach
      • Advanced Measurement Approaches
    • 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
  • Modelling 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 modelling
    • Quantifying the exposure and severity of “outliers” and tail risk
  • 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 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
    • 30 day stressed market outflows
    • Run off rates
    • 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

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