The Role of XBRL Based Solutions in Best Practice Enterprise Wide Risk Management (ERM) and Associated Risk Reporting

1. The Role of XBRL Based Solutions in Best Practice Enterprise Wide Risk Management (ERM)and Associated Risk Reporting April 27,2005 Dr Robert M. Mark Black Diamond & Hitachi America, Ltd.

2. Overview of Presentation • XBRL based solutions can help a Chief risk Officer (CRO)stay on top of a complex combination of “Characteristics” which are at the core of Superior Enterprise Wide Risk Management (ERM) solutions. • XBRL based solutions can help in proactively managing risk on an integrated portfolio basis covering market risk, credit risk and operational risk. • XBRL based solutions can also help to make risk transparent. • XBRL based solutions are highly applicable for credit analysts, equity analysts, fund mangers as well as commercial and industrial corporations. • XBRL based solutions are also helping to satisfy the requirements associated with the basic pillars of BASEL II as well as SOX 404 related requirements.

3. Enterprise Wide Risk Management • XBRL based solutions can help a Chief risk Officer (CRO) stay on top of a complex combination of “Characteristics” which are at the core of superior ERM solutions Customers Investors • The ability to efficiently integrate all the components of risk on a portfolio basis as well as to effectively operate in complex markets • While serving customers as well as satisfying regulators is a direct function of the quality of the policies, methodologies, and infrastructure Financial Risk -Market Risk -Credit Risk Non Financial Risk -Operational Risk -Business Risk Policies Infrastructure Regulators Rating Agencies Equity Analysts Markets Methodologies

4. Enterprise Wide Risk Management • XBRL solutions can help in proactively managing risk on an integrated portfolio basis • XBRL solutions can help at each of several layers of functionality = Portfolio Mgmt + Performance Measurement + Facilitate Loan Pricing + Approving Deals + Accounting Capital INCREASING use of XBRL REQUIRED Capital Management + Economic (Risk) Capital + Regulatory Capital (Basel) + Setting Provision (EL) Risk Analysis + Stress Test & Scenario Analysis + Value at Risk Limit Management + Monitor, Identify & Avoid Superior ERM Solutions

5. Enterprise Wide Risk Management • XBRL based solutions can help to make risk transparent. • Failing to adopt superior ERM solutions has been costly. • Major breakdowns in board related risk governance at complex risk-taking organizations such as at banks, securities firms, insurance entities, hedge funds, and energy companies • Large and well documented losses have occurred in firms such as at Bankers Trust, Metallgesellschaft, Barings, LTCM, Enron, etc. • Significant failures to detect accounting related errors such as at AIG and FNMA

6. Applicability of XBRL • Loan and credit analysts in banks could use these tools to evaluate commercial loan applicants. • Fund managers could use these tools to evaluate risk profiles of companies making up an investment portfolio. • Equity analysts and financial analysts could use these tools in making a Buy / Hold / Sell recommendation. • Commercial and industrial corporations could also use these tools to position their company relative to their competitors when meeting with the financial analyst community

7. Applicability of XBRL • Public companies that are working to satisfy the requirements associated with the basic pillars of Basel II and / or SOX 404 related requirements (3rd pillar)could use these tools as well Three Basic Pillars Minimum Capital Requirement Market Discipline Requirements Supervisory Review Process

8. Background • The 1988 Capital Accord was highly deficient • A one size fits all approach • Is not risk sensitive at the counterparty level • Does not recognize portfolio effects • Capital charge based on a proxy for credit risk – does not differentiate among other forms of risk • Capital charge being a function of the type of claim – sovereign, bank, others, rather than economic credit risk • Paradigm underpinning the capital requirement not explicit • Did not encourage investment in superior risk management

9. Background • Basel II Capital Accord is a significant improvement • Encourages investment in superior risk management tools (such as having an XBRL capability) • Broad coverage of all forms of risk • Menu of approaches from the least sophisticated to the most sophisticated • Wide scope: Includes Banks and Securities Firms • SEC allows Securities Firms to “Opt-In” • Capital being risk sensitive • Enhances reputation of those banks that achieve approval for most advanced Internal Ratings-based (IRB) approach • Potential of positively (or negatively) impacting credit ratings

10. The Internal Ratings-based Approaches • The Foundation Internal Ratings-Based (IRB) Approach • The Advanced Internal Ratings-Based (IRB) Approach

11. The Internal Ratings-based Approaches • The Foundation Internal Ratings-Based (IRB) Approach • The Advanced Internal Ratings-Based (IRB) Approach

12. The Advanced IRB Approach • The Advanced IRB approach requires statistically accurate measures of the credit risk drivers to obtain regulatory approval, such as • Exposure at Default (EAD) • Probability of Default (PD) • Loss Given Default (LGD) • Effective Maturity (M)

13. How XBRL Can Help? • For example, XBRL tools can help in collecting the necessary information to support the Credit Risk Analysis Process necessary to satisfy Basel II. • Financial Analysis is the first step of a nine (9) step process to arrive at a credit grade. Market Info (eg stock Prices) Dynamic Obligor Grade FacilityGrade Fundamental Analysis Analytics(eg Merton Model) 1 2 3 4 5 6 7 8 9 Static Our Demo Financial Info (eg EBIT)

14. How XBRL Can Help? • The 9 Step Process • 5 steps associated with Obligor Rating (for purposes of predicting Probability of Default) • Financial assessment • Quality of management • Borrower’s absolute and relative position within the industry • Quality of financial information • Country risk • 4 steps associated with Facility Rating (for purposes of predicting Loss Given Default) • Examining third party support • Factoring in the maturity of the transaction • Review of the structure of the transaction • Assessment of the collateral

15. Facility Rating (LGD) How XBRL Can Help? • The IRB system is the primary tool to set Provisions and Capital since it derives the calculation of Probability of Default (PD) and Loss Given Default (LGD) on a transaction basis. Collateral Transaction Structure Maturity of Transaction Third Party Support Managerial Capability,Competitive Position Obligor Rating (PD) Quality of Financial Information, Country Risk Financial Assessment (Floor on obligor rating)

16. E(VT)=V OemT How XBRL Can Help? • XBRL solutions can support both the IRB system as well as the mathematical models such as Merton’s Model (which requires a detailed understanding of the Balanced Sheet) which is used to predict PD. Assets Value Distribution of asset values at maturity of the debt obligation VT V0 F Probability of default Time T

17. 1. What is the probability of a counterparty going into default? “Probability of Default” PD = X 2. How much will that customer owe the bank in the case of default? (Expected Exposure) “Loan Equivalency” (Exposure at Default) EAD = X 3. How much of that exposure is the bank going to lose? “Severity” (Loss Given Default) LGD = How XBRL Can Help? • Regulators will not approve the risk driver (such as PD) unless it passes the use test, e.g. to predict Expected Loss (EL)

18. How XBRL Can Help? • Setting Provision Levels is an important outgrowth of XBRL related input to the IRB system. Product IRB Rating Client type Limit Utilization Collateral Value Collateral Category PD x EAD x LGD = EL What is the probability of default about the obligor? What is the risk exposure at this moment? How much is the loss at this default? obligor transaction

19. How XBRL Can Help? • Setting Capital Levels is also an important outgrowth of XBRL related input to the IRB system. Calculation of Capital under Standardised Approach Exposure Risk Weight 8% Capital Requirement x x = EAD BRW LGD Correlation Adjustment 8% Capital Requirement x x +/- x = BRW: Benchmark Risk Weight PD: Probability of Default LGD: Loss Given Default EAD: Exposure at Default PD Calculation of Capital under IRB Approach

20. How XBRL Can Help? • XBRL capabilities enable the user to access information of practical interest to credit analysts. These include: • Balance Sheet • Income Statement • Cash flow • Financial Assessment Measures (e.g. Solvency, Liquidity, and Leverage) • Key Operating Ratios • Industry Sector Analysis • Company Tier Analysis

21. How XBRL Can Help? • The first step of the credit rating process typically focuses on three key categories of ratios – Solvency, Liquidity, and Leverage. • A user can focus on any desired category for purposes of financial profiling.

22. How XBRL Can Help? • XBRL users can analyze a wide variety of key ratios that drive benchmark analysis. The major ratios aligned against credit rating include • 1. EBIT interest coverage 2. EBITDA interest coverage 3. Funds from operations/total debt 4. Free operating cashflow/total debt 5. Pretax return on capital 6. Operating income/sales 7. Long-term debt/capital 8. Total debt/capitalization

23. Obligor’s rating PD UL Facility rating LGD EL EAD How XBRL Can Help? • XBRL related input to RAROC performance measures is an important component of ERM solutions RAROC = Risk Adjusted Return on Capital = Net Income / Economic Capital FTP Management Accounting System Income, interest and fee Non-interest cost allocation - - Total income Operational cost Fund cost Hurdle rate Income Expected Loss (EL) - A business’s RAROC = Economic Capital (EC) • Pricing • Loan approval

24. How XBRL Can Help? • The RAROC Framework is based on comprehensive measures of risk • The RAROC Framework considers management objectives and constraints Transactions (within the authorized limit) Fixed and variable costs Authorized (limits) } Market risk Risk Adjusted Profit • OBJECTIVES and CONSTRAINTS • Objectives: • Revenues • ROE • Constraints: • Type of transaction • Authorized risk exposure • (e.g. OpVaR limit) = RAROC Economic capital Credit risk Operational risk

25. How XBRL Can Help? • XBRL bases solutions can help at multiple levels of the RAROC Performance Measurement Framework • RISK ADJUSTED RETURN • + Interest Income • + Non-Interest Income • +/- Indirect Revenue Sharing • - Interest Expense • - Non-Interest Expense • - Overhead Cost Allocations • Funding Charge (loan originators) • Expected Losses (EL) • + RORC ER C Risk Adjusted Return T = RAROC • RISK ADJUSTED CAPITAL • + Capital Required to Support Unexpected Risk Losses from credit, market and operational risks • - Capital Released by Correlation Effect Risk Adjusted Capital

26. Capital Standard A AA AAA Coverage Level 99.90% 99.97% 99.99% Probability Loss Rate Capital required to achieve target coverage • The Capital Allocation methodology achieves comparability of returns by assigning capital based on a common reference point across businesses • Economic capital is defined as the amount of capital needed to reach a given survival probability over a given timeframe How XBRL Can Help? • The economic capital level in the denominator of the RAROC equation is a function of the Confidence Level. Determining the appropriate Confidence Level (Coverage Level) will depend on both the nature of the institutions businesses and its risk tolerance

27. COMPARE SOLUTIONS A is Lower risk , higher profit than B Clear Preference! A B How XBRL Can Help? • Superior ERM institutions regularly review and invest in those business that have superior RAROC metrics and divest in those businesses that have inferior RAROC metrics. 115 110 105 100 95 Reward – average profit ($) 90 85 80 75 70 65 0 -100 -200 -300 -400 -500 -600 -700 -800 -900 -1,000 Risk – 1 in 100 year downside result ($)

28. CAPITAL RISK APPETITE PROFIT TARGET How XBRL Can Help? • For example: Superior ERM institutions regularly invest on those business along the efficient frontier in the upper left quadrant 115 110 105 100 95 Reward – average profit ($) 90 85 80 75 70 65 0 -100 -200 -300 -400 -500 -600 -700 -800 -900 -1,000 Risk – 1 in 100 year downside result ($)

29. PortfolioManagement Risk/Reward Optimization Portfolio Based Transfer Pricing Daily M-t-M Expected & Unexpected Loss Credit RiskManagement Sell Rating Updates ClientManagement Hedge Securitization Independent Risk Assessment & Rating Origination & Structuring Hold to Maturity PortfolioAdditions NewAcquisition Asset Purchase How XBRL Can Help? • For example XBRL solutions are part of the solution space that enable sophisticated financial institutions to evolve from a traditional buy & hold investor to active credit portfolio risk management. Superior ERM institutions regularly invest on those business along the efficient frontier in the upper left quadrant

30. Dr. Robert Mark • Dr. Robert M. Mark is the Chief Executive Officer of Black Diamond which provides corporate governance, risk management consulting and transaction services. He serves on several Boards such as the Fields Institute for Research in Mathematical Sciences, IBM’s Deep Computing Institute, Checkpoint Canada, The Royal Conservatory and Entergy Koch’s Audit Committee of the Board. He also serves on Checkpoint’s Investment Committee. In 1998, he was awarded the Financial Risk Manager of the Year by the Global Association of Risk Professionals (GARP). He is the Chairperson of The Professional Risk Managers’ International Association’s (PRMIA) Blue Ribbon Panel • Prior to his current position, he was the Senior Executive Vice-President and Chief Risk Officer (CRO) at the Canadian Imperial Bank of Commerce (CIBC). Dr. Mark was a member of the Management Committee. Dr. Mark’s global responsibility covered all credit, market and operating risks for all of CIBC as well as for its subsidiaries. Prior to his CRO position, he was the Corporate Treasurer at CIBC. • Prior to CIBC, he was the partner in charge of the Financial Risk Management Consulting practice at Coopers & Lybrand (C&L). The Risk Management Practice and C&L advised clients on risk management issues and were directed toward financial institutions and multi-national corporations. This specialty area also coordinated the delivery of the firm’s accounting, tax, control, and litigation services to provide clients with integrated and comprehensive risk management solutions and opportunities. • Prior to his position at C&L, he was a managing director in the Asia, Europe, and Capital Markets Group (AECM) at Chemical Bank. His responsibilities within AECM encompassed risk management, asset/liability management, research (quantitative analysis), strategic planning and analytical systems. He served on the Senior Credit Committee of the Bank. Before he joined Chemical Bank, he was a senior officer at Marine Midland Bank/Hong Kong Shanghai Bank (HKSB) where he headed the technical analysis trading group within the Capital Markets Sector. • He earned his Ph.D., with a dissertation in options pricing, from New York University’s Graduate School of Engineering and Science, graduating first in his class. Subsequently, he received an Advanced Professional Certificate (APC) in accounting from NYU’s Stern Graduate School of Business, and is a graduate of the Harvard Business School Advanced Management Program. He is an Adjunct Professor and co-author of “Risk Management” (McGraw-Hill), published in October 2000. He also served on the board of ISDA as well as the Chairperson of the National Asset/Liability Management Association (NALMA).