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Preparing for the 2014 EBA Stress Test Best Practices for Regulatory Stress Testing & Capital Modeling
Cayetano Gea-Carrasco, Moody’s Analytics, Stephen Clarke, Moody’s Analytics , Andy Condurache, PRMIA Originally presented as a part of a Moody’s Analytics and PRMIA webinar | April 29, 2014
2 Preparing for the 2014 EBA Stress Test
Welcome PRMIA Members
3 Preparing for the 2014 EBA Stress Test
Contents
1. Regulatory Overview
2. The 2014 Stress Test
3. Collateral Re-evaluation
4. Challenger Models
5. Data & Reporting
6. Q&A
4 Preparing for the 2014 EBA Stress Test
Regulatory Overview 1
5 Preparing for the 2014 EBA Stress Test
Global Regulatory Stress Testing Pressures Intensify Across Regions
Source – Moody’s Analytics market research and own analysis as of April 2014
EMEA
2013 2014 2015 2016 2017 2014 2015 2016 2017
CRD IV/CRR
CCAR/DFAST ST
EBA / ECB ST
B3/ CRDIV
Volker Rule
Review of trading book (market risk)
Large exposures/ concentration risk
Basel 3 (IRB) Vickers Reform
LEI
Review of Securitization rules
LCR framework
Basel 2 Basel 3
Global systemic risk report (FED)
Basel 3
UK FDSF Basel 3 (STD)
Stress tests FBO
Cover Bonds Rule 3
Review of trading book (market risk)
Large exposures/ concentration risk
Review of Securitization rules
Review of trading book (market risk)
Large exposures/ concentration risk
Review of Securitization rules
LEI
LEI
Basel 3
RBC 2/ ERM Ins. Inv.req
CROSS IBA
Superann. Req. Ins Prud. Stand
SAM
Full Solvency II
Solvencia II
SII-like P1 BMA
ORSA
SST
ORSA US
AIFMD
CRDIV AM?
MIFID II
UCITS Liquidity Stress Test
MMF Internal Ratings/ST
CCP EMIR
G-SIIs rules
G-SIIs rules
G-SIIs rules
SIFI surcharge & risk mgt
SIFI surcharge & risk mgt
SIFI surcharge & risk mgt
UK ICAS
NIMM
NIMM
COREP/ FINREP
ECB CR4
IFRS 4,9
LCR LCR
Insurance Capital Standard
Insurance Capital Standard
Insurance Capital Standard
Interim Measures
SII Interim Measures
NIMM
CCAR/DFAST ST
1.For transition to CRD IV / CRR 2.Under the EU CRR the LCR will be implemented faster than originally envisaged under Basel III. The timetable will be: 60% in 2015, 70% in 2016, 80% in 2017 and 100% in 2018 3.ECB Loan-level Reporting Requirements for Asset-backed Securities Backed by Credit Card Receivables 4.ECB Comprehensive Review: Portfolio Review, Asset Quality Review and Stress Test
Capital Plan Submission1
CRR LCR2
CRR LCR2
Qatar Insurance Prudential rules
IRDA risk-based solvency
Capital Rules & Final Market Risk Rule)
BoE / PRA ST (Top 8 banks)
BoE/PRA ST (Top 8 banks + Mid sized + SIFIs)
Internal Ratings
ICAAP
ICAAP / ILAAP
ICAAP / ILAAP
ICAAP / ILAAP
CCAR/DFAST ST
CCAR/DFAST ST
ICAAP
ICAAP
ICAAP
Retail Banks ST
FSA ST
FSA ST
FSA ST
Blue – Stress Testing-related Regulatory Requirements
Black – Other Regulatory Requirements
BoE / PRA ST
ICAAP
EBA/ECB ST
FI/Riksbank ST
FI/Riksbank ST
FI/Riksbank ST
Retail Banks ST
6 Preparing for the 2014 EBA Stress Test
United States vs. Europe – The Core Requirements of Stress Testing Regulations are Aligned Across Regions
Eurozone United Kingdom United States
Regulatory Body
Coverage
Disclosure
Modeling Approach
Frequency
Corrective Measures / Use of Outputs
Data Requirements / Reporting
Scenarios
EBA / ECB / NCA 1 BoE / PRA1 Federal Reserve
Annual Annual (regulator-led); semiannual (bank-led)
Annual (2009-2011 EBA); 2014 (ECB)
Largest UK Banks & Building Societies
Source – Moody’s Analytics
Public Disclosure of Results Public Disclosure of Results Public Disclosure of Results (Bottom-Up)
Bottom-Up & Challenger/Top-Down; Firms’ Own Models
Bottom-Up /Granular; Firms’ Own Models
Input Capital Adequacy CRDIV & firms’ PRA buffer; FPC Tool5
Common Stress, Bespoke Firm Stress, Common Baseline
Bottom-Up; Firms’ Own Models; Dynamic Projections
FDSF4 – Historical, Year-End Data & P/L Projections
FRY Reports – A/Q/M Data; P/L Projections
Historical/AQR Data – Core (ADC, TR, CSV) & Additional
(CSV) Templates2,3
Largest Eurozone/Significant Banks (approx. 128 banks)
BHC&FBO6; assets > than $10bn (DFAST), $50bn (CCAR)
Baseline, Adverse, Severely Adverse; Firms’ Scenarios
Input Capital Plan, Approval by Fed; Dividend Planning,…,etc.
Regulatory Baseline, Stress Scenario
Recapitalization Plan
1.European Banking Authority (EBA), European Central Bank (ECB), National Competent Authorities (NCA), Bank of England (BoE), Prudential Regulation Authority (PRA) 2.Asset Quality Review (AQR) 3.Advanced data collection (ADC), Transparency (TR) and Calculation, Validation & Support (CSV) Templates 4.Firm Data Submission Framework (FDSF) 5.Financial Policy Committee (FPC); Capital Requirements Directive IV (CRD IV) 6. Bank Holding Companies (BHC), Foreign Banking Organizations (FBO)
7 Preparing for the 2014 EBA Stress Test
The 2014 Stress Test 2
Preparing for the 2014 EBA Stress Test
Structured Corporate CRE C&I Retail
Forecast RWA
Required Capital
Forecast NCO / ALLL
Forecast Other Losses
Forecast Net Interest Income
Forecast Non-Interest
Inc / Exp
PPNR / PPNP
Changes to Available Capital
Business Forecasting
Models
Forecast Positions
P & L Models
Financial Planning & Analysis
• Other revenue • Op losses • Trading losses • Counter-party
losses • Other expenses
Forecast Positions
Treasury / ALM
• Base Runoff • New Business
Interest Income / Expense Models
Market Risk
Strategy / Risk
Appetite
Regulatory Reports
Key Performance Indicators / Balanced Scorecard Variables
Source Database
Source Database
Source Database
Current Positions Regulator Scenarios
Stress Testing Inputs
Economic Variables and Alternate
Scenarios
Pricing Curves
C & I
Credit Models
CRE
Mortgages
Credit Cards
Auto
Other
Forecast Positions
Op Risk
Market Risk
Risk
8
8
The Stress Testing Calculation – The Big Picture
9 Preparing for the 2014 EBA Stress Test
Comprehensive Review – Preliminary Timelines
Phase I The ECB is appointed as the SSM – Supervisory
Risk Assessment Process (SRA)
Publication 2014 Stress Test Scenarios
European Systemic Board/ECB/EBA
ECB fully assumes the supervisor tasks in the
Eurozone One year after being
appointed SSM – Publication Comprehensive Assessment
Results
Q1 2014 Q2 2014 Q2/Q3 2014 Q4 2013 Q4 2014
Phase II Asset Quality Review
(AQR) – ECB publishes AQR manual & EBA
publishes Stress Test manual
Phase III EBA Stress Test
Results ST/AQR Published (October)
2015 – Resolution Being Initiated
For those banks unable to raise capital privately after
the CR
10 Preparing for the 2014 EBA Stress Test
The 2014 European Stress Test will be Administrated by the EBA; Part of the ECB Comprehensive Review
Static Balance Sheet
2013 Consolidated, Year-End Data Same Business Mix No currency Effects No workout of defaulted assets
Harmonized NPLs
Definitions
128 Banks
Insurance Activities Excluded
22 EU Members
Baseline &
Adverse Scenarios
Country Specific (NCAs)
Hurdle Rates 8%
CET1 Baseline,
5.5% Adverse
Transitional NCAs may Assess Fully
Loaded AT1/AT2 Conversion
Trigger 5.5%
Performing Non-Performing
Forbearance Defaulted
11 Preparing for the 2014 EBA Stress Test
Key Aspects – Risk Coverage, Treatment & Disclosure
Highest level of consolidation
Trading & Banking books
Operational, Credit, Market, Sovereign risk, Securitisation, Funding Cost
Additional risks may be requested to be assessed by the NCAs
Disclosure will be consistent with the 2011/2013 EBA stress tests
Additional disclosure about capital, sovereign holdings & risk exposures
Trading book & Available-for-Sale Portfolios
MtM
Sovereign Portfolios
HtM
Recalibration of the RWAs
12 Preparing for the 2014 EBA Stress Test
Key Aspects – Bottom-Up Methodology
Macro scenarios released today
NCAs may add country-specific variables to the scenarios
Credit Risk Methodology (Complex)
Point-in-Time; Caps & Floors
Model the default of a counterparty
Linkage macro economic scenario with default & loss parameters (provisions/RWA)
Market Risk Methodology (Simple)
Common set of stressed market parameters will be applied
IRC and CVA will be stressed
Uncertainties
Backstops, remediation actions & how to meet capital shortfalls/raise capital
Final methodology, dates, regular exercise, Sovg. filters, definition of the scenarios
13 Preparing for the 2014 EBA Stress Test
Key Aspects – Scenarios
The scenario is triggered by increased global bond yields, worsening credit quality in troubled countries, lack of reforms, and a weaker banking sector
Output in euro zone declines 0.7% in 2014 and 1.4% in 2015. The corresponding declines in the U.K. are 0.8% and 1.3%
One-year euro swap rates rising 115 bps above baseline in 2014. In the euro area, house prices decline to 11% and stock prices 18.1% below the baseline forecast in 2016. Disinflation is experienced in many countries and the euro zone unemployment rate peaks at 13.5% in 2016
In the terms of a peak-to- trough decline, the stress scenario features a milder recession as compared to Severely Adverse Scenario published by the Federal Reserve for the CCAR exercise last year or the Anchor scenario generated by Prudential Regulation Authority in the U.K.
14 Preparing for the 2014 EBA Stress Test
Expectations from Regulators – Effective Stress Testing Programs
Stress Testing Infrastructure
Dedicated Resources
Governance Framework
Stress Testing Methodologies
Reverse Stress Testing
Capital & Budgeting Planning
Contingency/Recovery/Resolution Planning
Scenario Analysis
Sensitivity Analysis
Management Actions
Risk Appetite
15 Preparing for the 2014 EBA Stress Test
Collateral Re-evaluation 3
16 Preparing for the 2014 EBA Stress Test
Level III Fair Value Exposure Review as part of AQR/Comprehensive Assessment
Independent Revaluation
• Revaluation of Level 3 Non-Derivative Assets
Process and Model
Review
• Trading Book Core Processes Review • Level 3 Derivative Pricing Models
Review
Each NCA bank team must carry out the Level 3 Fair Value Exposures Review, which is divided into two main components.
17 Preparing for the 2014 EBA Stress Test
Revaluation of Non-Derivative Assets Requires Independent Valuations of Multiple Illiquid Assets at both Asset and Portfolio Levels The most material assets in each material asset class have been sampled across the trading and banking books and will be independently revalued by the NCAs and their contracted third parties.
Fair-Valued Loan Portfolios
Level 3 Single Name Bonds
Level 3 Securitisations
Held Real Estate
Part. & Indiv. PE
Investments
Significantly lower values from the independent revaluation will lead to adjustments in carrying amounts and increases in reserves.
18 Preparing for the 2014 EBA Stress Test
Level 3 Valuations Require Multiple Assumptions with Limited Observable Data: Securitisation as an Example
Calculate Final Price Fundamental Cash Flows Generated from Above
Assumptions Market-Implied Discount Rates based on Some
Observable Information
Forecast Tranche Cash Flows Using Waterfall Models Transaction-Specific Capital Structure & Payment
Rules Transaction-Specific Triggers, Reserve Accounts,
Liquidity Facilities, etc.
Assess Counterparty & Optionality Outcomes Forecasting Counterparty (e.g., F/X & IR Swaps,
Liquidity Facility Providers) Behaviour Issuer and/or Investor Call Options
Forecast Future Underlying Collateral Performance Historical Performance versus All Similar
Collateral Historical Correlation with Macroeconomic
Variables and Forecasted Economics
Uncertainty is embedded in each assumption at each step of the valuation process.
19 Preparing for the 2014 EBA Stress Test
Slight Changes in Assumptions During Revaluation can Result in Large Changes in Values
Seemingly innocuous changes in assumptions (for example default and prepayment vectors) can drive significant movements in cash flows and final prices
0%
20%
40%
60%
80%
100%
1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
Collateral Loss
Tran
che
Prin
cipa
l R
etur
n
Collateral Loss ∆1% Tranche loss ∆100%
Many banks implementing internal Challenger Models in preparation to uncover issues ahead of external/regulatory challenges
20 Preparing for the 2014 EBA Stress Test
Challenger Models 4
21 Preparing for the 2014 EBA Stress Test
Understanding Challenger Models Regulator: “…challenger model is a prudential measure to enable regulators a quantitative challenge of
the bank’s model and its calibration”
Bank: “…challenger model is a prudential measure to enable senior management a quantitative challenge of the business’ forecast and loss/hedging’s assumptions under stress”
Part of the AQR & Stress Tests
CVA, Cure Rate, LGL, LGI, PI, Provisions
Usually aligned with accounting requirements
Top-down or bottom-up
Statistical/actuarial versus cash-flow/competing risk
Extreme care must be applied towards general, portfolio-wide approaches
Benchmark bottom-up results (focus on level, not on value) / outliers
Provide floors & caps metrics
Proper Calibration & enough Data History adapted to the business model are key
Banks have raised concerns about those Challenger Models used in the AQR
22 Preparing for the 2014 EBA Stress Test
Data & Reporting 5
23 Preparing for the 2014 EBA Stress Test
The Data Collection Process for the AQR & Stress Test is Novel & Unique; Very Intensive in Resources
Very close linkage between the AQR and the Stress Test
New Segmentation for Clients & Exposures in the Banking Book that does not correspond to NACE codes or risk sectors
Notional amounts in the Trading Book must be re-valued as at December 31, 2013 using IFRS 13 hierarchy
More than 12 different asset classifications and +150 criteria for the Real Estate portfolio
Application of the 2013 EBA Forbearance & Performing/Non-Performing definitions for the Banking Book – First FINREP application in September 2014
Decomposition by files of the accounting collective provisions is not common in all the EU countries
24 Preparing for the 2014 EBA Stress Test
Institutions Are Requested to Submit Core Templates; Additional Templates may be Requested by the NCAs
Core Templates
ADC – Advanced data Collection
TR – Transparency
CSV – Calculation support &
validation data
Additional Templates
CSV – Calculation support &
validation data
25 Preparing for the 2014 EBA Stress Test
Institutions Are Requested to Submit Core Templates; Additional Templates may be Requested by the NCAs
Core Templates
Advanced data collection
Transparency
Calculation support &
validation data
Additional Templates
Calculation support &
validation data
Advanced Data Collection – Credit Risk Credit Risk
Balance Sheet
COREP – driven
Standard & IRB Methods
Exposures
PD, LGD, RWAs
Provisions, Defaulted & Valuation
26 Preparing for the 2014 EBA Stress Test
Institutions Are Requested to Submit Core Templates; Additional Templates may be Requested by the NCAs
Core Templates
Advanced data collection
Transparency
Calculation support &
validation data
Additional Templates
Calculation support &
validation data
Transparency – Exposures & Solvency CR 2014 Baseline & Adverse
CR 2015 Baseline & Adverse
CR 2016 Baseline & Adverse
CVA
Securit BB, TB Standard
Securit BB, TB IRB
RWA by Risk Type
Capital ratio & Solvency
Exposures
27 Preparing for the 2014 EBA Stress Test
Institutions Are Requested to Submit Core Templates; Additional Templates may be Requested by the NCAs
Core Templates
Advanced data collection
Transparency
Calculation support &
validation data
Additional Templates
Calculation support &
validation data
Calculation Support & Validation – Market/Credit/Funding Risk
Sovereign
RWA Evolution, Standard, IRB, Trading
P&L Evolution
Security Summary
Capital, Restructuring
Market Risk
Capital & RWAs Projections
Sovereign Risk
28 Preparing for the 2014 EBA Stress Test
Calculation Servers
Integrated Risk & Finance Infrastructure is a Necessary Condition
Data Mart
Results Data Admin
TL Platform
Historical Data Series
Bank Source Systems
Market And Credit
Data
Workspace
Workspace
Workspace
Data Quality Checks, GL Reconciliation Adjustment & Audit
Advanced security, access management, and audit features
Regulatory and Internal Reporting
Run stress tests
Capital & RWA Planning
Scalable pool of computer resource, reducing calculation time
Supports multi-source data feeds - synchronised or not
Complete data loading platform
29 Preparing for the 2014 EBA Stress Test
Data & Infrastructure are the Major Building Block for an Effective Stress Testing Framework – Wish List
When implementing and automating the stress testing framework, data centralization, data quality, and systems’ integration is probably the most time-consuming and costly task
Enterprise-wide View – Consistent view at a group and subsidiary level; meet regulatory requirements across jurisdictions
Multiple Models (internal & third-party vendor) – Development and deployment of multiple models (top-down, bottom-up) from different stakeholders
Cost-Effective – Internal build is usually too costly, too slow and not reactive enough to support changing requirements
Scalability, Maximizes Return-on-Investment – Highly configurable framework to support changing and varied methodologies
Drill-down & Auditing Capabilities – Users are able to drill-down at a loan level data; audit the stress testing’s results and end-to-end workflow
Off-the-Shelf Regulatory Reporting – Produces stress testing regulatory reporting and reconcile results across jurisdictions
30 Preparing for the 2014 EBA Stress Test
Q&A 6
31 Preparing for the 2014 EBA Stress Test
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