ERSTE GROUP Challenge ICAAP Andreas Weingessel Group Risk Control September 9, 2008 Page 1
Agenda ERSTE GROUP − Introduction − Basel II – From Pillar 1 to Pillar 2 − Basel II – Pillar 2 − Risks to be considered − Challenges in modeling these risks − Enterprise-wide Risk Management Andreas Weingessel / Group Risk Control September 9, 2008 Page 2
ERSTE GROUP Slide taken from the presentation in the AGM Andreas Weingessel / Group Risk Control September 9, 2008 Page 3
Org Chart of Group Risk Management ERSTE GROUP Chief Risk Officer (CRO) Group Risk Management Group Credit Group Market & Group Risk Control Risk Reporting Liquidity RM Enterprise-wide Group Operational Group Credit Group Rating RM Risk Control Risk Methods Methods Andreas Weingessel / Group Risk Control September 9, 2008 Page 4
Agenda ERSTE GROUP � Introduction − Basel II – From Pillar 1 to Pillar 2 − Basel II – Pillar 2 − Risks to be considered − Challenges in modeling these risks − Enterprise-wide Risk Management Andreas Weingessel / Group Risk Control September 9, 2008 Page 5
Basel II - Overview ERSTE GROUP Basel II Pillar 1 Pillar 2 Pillar 3 Minimum Capital Requirements Supervisory Review Process Market Discipline � Risk adequate capital � Continuous risk � Enhanced disclosure management process � All specific bank risks � Better assessment for and other risks capital � Evaluation of bank's market participants of internal capital adequacy capital adequacy of � Market risk in the assessment process banks trading book (ICAAP) � Increase of market � Credit risk � Definition of bank's discipline � Operational risk individual solvability- coefficients Andreas Weingessel / Group Risk Control September 9, 2008 Page 6
Pillar 1 Capital Requirements – Credit Risk ERSTE GROUP − Capital = Exposure x RWA x 8% − RWA: Risk Weighted Assets − Basel I − RWA depend on type of client (0%, 20%, 50%, 100%) − Basel II 300% − f (Internal Rating) 250% 200% 150% 100% 50% 0% 0% 20% 40% 60% 80% 100% Andreas Weingessel / Group Risk Control September 9, 2008 Page 7
Pillar 1 Capital Requirements – Market Risk ERSTE GROUP − No substantial change from previous regulation − Internal Model − 99% VaR per 10 days x Factor − Factor is ≥ 3. − Higher Factor − Qualitative deficiencies − Too many outliers in Backtesting Andreas Weingessel / Group Risk Control September 9, 2008 Page 8
Pillar 1 Capital Requirements – Operational Risk ERSTE GROUP − Basic Indicator Approach − Gross Income x 15% ( α -Factor) − The Standardized Approach − Mapping of Gross Income to standardized Business Lines − Per Business Line: Indicator (Gross Income) x β -Factor (12%-18%) − Advanced Measurement Approaches (AMA) − Internal Risk Models (99.9% VaR/1y) for capital calculation Andreas Weingessel / Group Risk Control September 9, 2008 Page 9
Regulatory Capital vs. Economic Capital ERSTE GROUP Risk Basel I Basel II Best Practice Erste Bank AG Yes, but not risk significant Counterparty Risk sensitive improvements Creditrisk Yes, but not risk significant Concentration Risk Portfoliomodel based sensitive improvements Internal model (VaR) on Credit-Value-at-Risk (CreditManager) Transfer Risk No No Yes, but not risk significant Settlement Risk sensitive improvements Market- Trading book Internal model (VaR) Internal model (VaR) risk Internal model (VaR) Internal model (VaR) Interest risk in the No Monitoring (Pillar II) Banking book Yes, but not risk significant Equity risk Internal model (VaR) No sensitive improvements Real estate risk No No Internal model (VaR) No yes, different Operational Risk No Internal model (VaR) Internal model (VaR) approaches Business Risk No No Internal model (VaR) Internal model (VaR) Liquidity Risk No Monitoring (Pillar II) Internal monitoring Internal monitoring Total Risk = Riskaggregation Total Risk = MR+CR+OR Correlations / Copulas Correlations / Copulas MR+CR Andreas Weingessel / Group Risk Control September 9, 2008 Page 10
Agenda ERSTE GROUP � Introduction � Basel II – From Pillar 1 to Pillar 2 − Basel II – Pillar 2 − Risks to be considered − Challenges in modeling these risks − Enterprise-wide Risk Management Andreas Weingessel / Group Risk Control September 9, 2008 Page 11
Basel II – Supervisory Review Process (Pillar 2) ERSTE GROUP SRP SRP (Supervisory Review Process) (Supervisory Review Process) ICAAP SREP ICAAP SREP (Internal Capital Adequacy (Supervisory Review and (Internal Capital Adequacy (Supervisory Review and Assessment Process) Evaluation Process) Assessment Process) Evaluation Process) RAS RAS prime responsibility (Risk Assessment System) (Risk Assessment System) of bank management Andreas Weingessel / Group Risk Control September 9, 2008 Page 12
Definition of Economic Capital ERSTE GROUP Economic Capital is ... an adapted Value-at-Risk, calculated � with horizon 1 year � at a confidence level that reflects the default probability of Erste Banks aspired rating 99,95% confidence level Economic Capital is the minimum capital necessary to cover unexpected losses Andreas Weingessel / Group Risk Control September 9, 2008 Page 13
Targeted Rating and Economic Capital ERSTE GROUP Confidence Level Capital Requirement = f (Target Confidence Level) 99,97% ∅ 99,95% 99,93% Rating A- A A+ AA- AA (0,09%) (0,07%) (0,05%) (0,04%) (0,03%) Current Target Rating Rating Andreas Weingessel / Group Risk Control September 9, 2008 Page 14
Capital (99,95%) ERSTE GROUP Definition: Available bank capital to cover losses. Components (exemplary): � Equity - Shareholder capital - Reserves - Funds for general bankrisk � Hidden Reserves � Overendowment in provisions, general bad debt charge, ... � Item to be deducted Devaluation of fixed assets (i.e. securities) Andreas Weingessel / Group Risk Control September 9, 2008 Page 15
ICAAP (Internal Capital Adequacy Assessment Process) – High Level Principles ERSTE GROUP The ICAAP should be proportionate to the nature, size, risk profile and complexity of the institution. (1) Every institution must have a process for assessing its capital adequacy in relation to its risk profile (an ICAAP). (2) The ICAAP is the responsibility of the institution. (3) The ICAAP should be formal, the capital policy fully documented and the management body’s responsibility. (4) The ICAAP should form an integral part of the management process and decision- making culture of the institution. (5) The ICAAP should be reviewed regularly. (6) The ICAAP should be risk-based. (7) The ICAAP should be comprehensive. (8) The ICAAP should be forward-looking. (9) The ICAAP should be based on adequate measurement and assessment processes. (10) The ICAAP should produce a reasonable outcome. Andreas Weingessel / Group Risk Control September 9, 2008 Page 16
Capital – Economic Capital ERSTE GROUP Business Capital Business Risk Risk Capital Diversi- + Shareholder Central Diversi- Op. Central Op. fication Capital Capital fication Risk Capital Risk Reserve Reserve + Reserves + Hidden Economic Reserves Capital Limit + Overendowment Credit- in provisions, Credit- risk general bad debt risk econom. econom. Minimum- charge Minimum- capital capital - Devaluation of (EC Limit) (EC Limit) fixed assets (i.e. Market- Market- securities) risk risk Andreas Weingessel / Group Risk Control September 9, 2008 Page 17
Agenda ERSTE GROUP � Introduction � Basel II – From Pillar 1 to Pillar 2 � Basel II – Pillar 2 − Risks to be considered − Challenges in modeling these risks − Enterprise-wide Risk Management Andreas Weingessel / Group Risk Control September 9, 2008 Page 18
Classification of Banking Risks ERSTE GROUP Enterprise-wide Risk Quantifiable Risks Strategic Risks (effect on return < 1 year) (effect on return > 1 year) Credit Risk Market Risk Operational Risk Credit Risk Market Risk traditional Trading Book Credit Risk Market Risk Treasury Banking Book Market Liquidity Risk Andreas Weingessel / Group Risk Control September 9, 2008 Page 19
Classification of Banking Risks ERSTE GROUP Enterprise-Wide Risk Business Operational Risk risk Own Op. Risiko as Assets Event Risk part of credit risk Equity Risk Process IT - System Reputational External Risk Employees Liquidity Risk Andreas Weingessel / Group Risk Control September 9, 2008 Page 20
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