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ICAAP CHALLENGES FOR THE BOARD

ICAAP CHALLENGES FOR THE BOARD. Dr David Bobker Asian Institute of Finance. ICAAP. Quantified assessment is required Pillar 1 is just a starting point Cannot rely on standardised approach Stress testing key element – in particular reverse stress testing= inverse risk logic.

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ICAAP CHALLENGES FOR THE BOARD

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  1. ICAAPCHALLENGES FOR THE BOARD Dr David Bobker Asian Institute of Finance

  2. ICAAP • Quantified assessment is required • Pillar 1 is just a starting point • Cannot rely on standardised approach • Stress testing key element – in particular reverse stress testing= inverse risk logic

  3. Challenges for the board • Understanding the risks • Setting the risk appetite • Credible ICAAP and capital adequacy

  4. Understanding the risks • Cannot wholly delegate to management – required to sign off on capital • Regulator placing more responsibility on the board • Quantified risk must be the basis of an ICAAP • Is the board able fully to understand the quantum of risk even at a broad level? • Examples: interest rate risk; concentration risk

  5. Some questions for the board • Has the board actually considered its own ability? • What can the board do if it believes it needs additional capability? • Is board making use of bank’s own professionals?

  6. Challenge 2 setting appetite • Understand what isappetite? • DEFINITION: appetite=decision whether or not to accept the current situation with regard to all identified potentially catastrophic scenarios • Requires careful consideration of the meaning of catastrophe AND identification of the catastrophic scenarios

  7. Inverse Risk Logic • Process of working backwards from potential catastrophes to drivers and associated control failures • Opposite of usual approach of considering lots of scenarios and asking what is their effect • Focuses only on catastrophe • But what is catastrophe?

  8. Catastrophe and leverage • Loss of only a proportion of capital is catastrophic • Suppose you can only afford to lose 30% of capital then YOUR EFFECTIVE LEVERAGE IS 3 TIMES ACTUAL • Second – if the “probability” of loss of capital (per Basel) is 0.1% then the corresponding probability of losing 30% of capital is much greater

  9. How much can you lose? Regulatory Capital Safety margin 8% RISK WEIGHTED ASSETS RISK ASSET RATIO

  10. How much can you lose? Loss of capital NON VIABLE Regulatory Capital 8% RISK WEIGHTED ASSETS RISK ASSET RATIO

  11. Leverage principle Regulatory Capital RISKY ASSET BASE Very small compared to asset base – significant compared to capital

  12. Final Challenge • Board needs to ensure there is a CREDIBLE ICAAP and ADEQUATE CAPITAL • This may put it head on with Executive Management’s plans • It is then a matter of choice for board members

  13. THANK YOU 13

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