Workshop AFGAP-ALMA Professional training in ALM 11 May 2012

1. Workshop AFGAP-ALMAProfessional training in ALM11 May 2012

2. ALM Professional training in France • As of now, only in-house ALM training programs do exist in France • For example, Société Générale and BNPP have developed their in-house programs exclusively dedicated to their own employees • As far as we are aware, there is no academic-based training specifically oriented toward asset-liability management • Nevertheless, many academic programs on asset management, risk management, mathematical finance, actuarial sciences etc. do actually exist • AFGAP has been working on a comprehensive training program in ALM under the following guidelines: • mostly oriented towards banks (versus insurance companies) • sponsored by AFGAP and its stakeholders • anchored in one (or more) academic institution, for example ENSAE which is one of the leading graduate school in economics, finance and quantitative analysis • delivering both academic and professional certification

3. ALM Professional training in France: An example • Level 1 (2-3 days) • Intoduction to banking book risks • Definition, economic and regulatory context, main challenges about Liquidity Risk • Definition, economic and regulatory context, main challenges about Interest Rate Risk • Definition, economic and regulatory context, main challenges about Currency Risk • Organisation, gouvernance and risk policies • Level 2 (2-3 days) • Focus on balance-sheet / off balance sheet main exposures • Modeling of maturing / non maturing products • Liquidity gap, interest rate gap, risk measurement • Main risk indicators: gaps, duration analysis, interest rate margin sensitivity, present value, Earnings-at-Risk • Static liquidity gap and on-going concern gaps • Hedging and Funding Transfer Prices • Regulatory context: ratios, accountancy rand prudential requirements • Level 3 (2-3 days) • Option modelling in ALM: interest-rate-capped loans, fixed/variable rate loans, early repayment/termination etc. • Off-balance sheet and non-plain vanilla hedging products: swaptions • Non-linear risk modeling • Advanced hedging • Economic capital and capital management

4. ALM Professional training in France: An example • Employees targeted : • ALCO members • ALM employees in F/O and B/O departments • Risk managers • Internal auditors / Accountants • Quants • Budgeting and Capital planning executives • All employees in Finance divisions, Retail and Corporate management units etc.

5. ALM Professional training in France: AFGAP objectives • AFGAP Objectives • Extending in-house program to set up a 80-hour program aimed at training any employee from AFGAP stakeholders • Providing trainees with a common and unified package of skills and core competences • Enhancing ALM culture in France to strengthen banks position when discussing with French and foreign regulators • Developing an international english-based training program in the coming years • Enrolling supervisory bodies’ and regulators’ employees in the program • Connecting ALM with academic curriculum in order to develop academic research in this field

6. Example of a training program - 4 modules Fundamentals of structural risks management E-learning of 80 slides. Level 1 - Introduction to structural risks management 2-day training in a classroom with exercices Level 2 – Advanced practice for the management of structural risks 2-day training in a classroom with exercices and a case study Level 3 – Management of implicit and explicit options in ALM 2-day training in a classroom with exercices 07/08/2014 6

7. I. Fundamentals of structural risks management 07/08/2014 Summary • Introduction. • The yield curve. • Intermediation activity and the ALM perimeter. • The schedule and gap principles. • Liquidity, interest rate and foreign exchange risks. • Fund transfer pricing. • ALM function regulation and organization. 7

8. II. Level 1 - Introduction to structural risks management 07/08/2014 Summary – 1st Part • Introduction to structural risks and their management • Banking intermediation • The bank balance sheet • Origins and impact of structural risks • Principles and tools for structural risks management • Liquidity risk and its management • Origins and impact of liquidity risk • Liquidity spread • Illustration: the 2007-2008 and 2009-2011 financial crises • Measuring liquidity risk: indicators • Managing liquidity risk • Regulatory guidelines regarding liquidity risk 2011 2012 2013 2014 2015 2016 2017 2018 8

9. II. Level 1 - Introduction to structural risks management 07/08/2014 Summary – 2nd Part • Interest rate risk and its management • Origins and impact of interest rate risk • Interest rate risk illustrations • First interest rate risk measurement: the interest rate gap • Building the interest rate gap: illustrations • Second interest rate risk measurement: sensitivity. • Managing interest rate risk • Fund transfer pricing • Regulatory guidelines regarding interest rate risk • Currency risk and its management • Origins and impact of currency risk • Scope and measurement of currency risk • Managing currency risk • How risk management is organised in a bank • Regulatory guidelines and their transposition to banks • The role of ALM within a bank • The parties involved in risk management 2011 2012 2013 2014 2015 2016 2017 2018 9

10. III. Level 2 - Advanced practice for the management of structural risks 07/08/2014 Summary – 1st Part • Reminders about the basics • Reminders on structural risk • Reminders about the yield curve • Scheduling of balance sheet items • Contract Maturities and modeling principle • Prepayments • Non scheduled deposits and modeling principles • Off Balance sheet commitments • Reserve requirements • Overdrafts 2011 2012 2013 2014 2015 2016 2017 10

11. III. Level 2 - Advanced practice for the management of structural risks 07/08/2014 Summary – 2nd Part • Indicators and hedging of structural risks • Interest rate risk • Liquidity risk • Fund Transfer Price • External Regulation • Special Cases: the shareholders' equity in the management of structural risks • Definitions • Group Principles on the reinvestment (re-investment) of Shareholders’ Equity • Case study: preparing and conducting of the ALM Committee 2011 2012 2013 2014 2015 2016 2017 2018 11

12. IV. Level 3 - Management of implicit and explicit options in ALM 07/08/2014 Summary • Part 1 - Modeling prepayments • Part 2 - Modeling of home-buyer's savings plan • Part 3 - Review of the notions of convexity, duration and sensitivity • Part 4 - Pricing of a cap • Part 5 - Calculation of optional ITR • Part 6 - Value at Risk • Part 7 - Economic Capital required for the interest rate risk 2011 2012 2013 2014 2015 2016 2017 2018 12

13. 07/08/2014 Illustrations 13

14. Banking intermediation The fundamental role of a commercial bank is to: Raise funds from its customers (resources); Grant loans to various customers (uses). Examples: This is a bank's intermediation role. deposits salaries loans 14

15. The bank balance sheet ASSETS LIABILITIES CUSTOMER USES CUSTOMER RESOURCES Balance sheet SHORT-TERM FINANCING MARKETS LONG-TERM FINANCING FINANCING FIXED ASSETS SHAREHOLDERS’ EQUITY COMMITMENTS GIVEN COMMITMENTS RECEIVED Off-Balance sheet MARKET TRANSACTIONS MARKET TRANSACTIONS 15

16. Principles and tools for risk management In order to guarantee that the Commercial Department receives its due share of the margin, the bank has set up the ALM Department, which matches every customer loan and every customer deposit at the market rate by going through the bank’s Treasury. 4.5% over 5 years 3% over 3 months 2% over 3 months ALM Department 3% over 3 months 5% over 5 years 4.5% over 5 years 16

17. Principles and tools for risk management Transformation and anti-transformation Two words with opposite meanings: Transformation: short-term resources of funding matched by long-term uses Anti-transformation: means borrowing long to lend short The transformation margin: is the gain realised on the difference between short and long-term rates. Transformation: margin if the curve is positive Anti-transformation: margin if the slope is negative 17

18. Interest rate risk hedging Example 1: Hedging by term borrowings starting spot (if there is no swap market ) 18

19. Building the liquidity gap: illustrations Example: Fixed term loan falling due in 10 years (a kind of repayment loan with constant payment intervals). 19

20. Building the liquidity gap: illustrations Example: building a liquidity gap - Assets Liquidity risk 20

21. Origins and impact of interest rate risk • Market rate volatility. Inversion of the yield curve Flattening of the yield curve Steepening of the yield curve 21

22. Internal transfer rate Principle of notional backing within ALM Example with a loan customer. Example with a client term deposit. Branch ALM Client Virtual Loan same characteristics as the loan customer Loan to the client ALM Client Branch Virtual Placement same characteristics as the customer deposit Customer deposit 22

23. Internal transfer rate The internal transfer rate (ITR) intervenes in the interest margin breakdown : Example for a loan that the Branch performs with his client: Branch Markets Treasury ALM Client CUSTOMER RATE Interes Gross Margint Net interest income credit ALM margin Cash margin ITR ALM REFUNDING RATE MARKETS REFUNDING RATE Margin = Sales + structure + costs + Credit costs Cost of Equity ... 23

24. Internal transfer rate Example 1: Indexed rate loan Commercial margin: 1.1% Liquidity: 0.4% Customer rate 3M EURIBOR + Margin : 3.5% FTP 2.4% 3M EURIBOR: 2% 24

25. Internal transfer rate Example of calculation for a profile depreciable/amortizing profile? (non-linear). amount 75 ITR 1 year = 2.5% ITR 2 years = 3.55% ITR 3 years = 4.15% ITR 4 years = 4.75% ITR 5 years= 5% 1 year 2 years 3 years 4 years 5 years Period Sum ( ITR  Area) = 4.34% Sum ( Area) 25

26. Calculation of the sensitivity within SRC ALM has tried to approach the sensitivity formula for a variation of 1%. We can write that the value of a loan of a nominal 1 and of annual coupon C is equal (with a single discount rate) to: The change in value of the loan to an increase of 1% is written as: For a loan, we recall that if rates rise, its value decreases. The cash flows Gap represents the trades to be set up to immunize the position. 26

27. Calculation of the sensitivity within ALM If the trade to be set up is a loan and is not hedged, the entity will realize a gain if rates rise. To characterize this gain, we will write that the change in value of the loan must be positive and will be calculated as follow : 27

28. Prepayment modelling: • Step 1 - Calculation of the outstanding loan balance • Step 2 - Calibration of the seasonality parameters by stratification • Step 3 - Calibration of the parameters of seasoning by stratification • Step 4 - Calibration of the dependence on interest rate • Step 5 - Validation : consistency & predictive power 28

29. Step 2 - Modeling of the seasonality • Stratification : • To avoid rate effect on seasonal coefficients, we sort the couples (i,t) of loan i and date t in 10 divisions that we call “strate”. • Prepayment rate by division • Minimization 29

30. Step 4 – PP Dependence on interest rates In theory, there is a level of interest rates at which all rational agents would have to prepay. Thus we seek a function with a “threshold effect" to illustrate the dependence of PP on interest rates. Arctangent function with rate dependent coefficients Minimization 30

31. Exercice