In most of the bank's assets and liabilities management aims to manage interest rate risk on bank balance sheets and ensure that the interest rate risk inherent in the bank's business does not disturb the stability of bank earnings.
Source of bank income is reflected from the Net Interest Income is the difference between lending rate and interest rate funds. Current Value / Net Present Value of the NII is the main contributor of the goal to stabilize the NII can be said also to stabilize the business value (this description commonly used in America).
The emphasis of a bank on both goals often depends on accounting management conducted → whether the report reflects the bank's management primarily from income or value. Management accounting consists of a reporting structure based on financial information that reflects the way the business at the bank management. On the other hand reports as provided by law like the report Income statement and balance sheet must be in accordance with the standards and laws of national accounting standards. Management accounting, are often influenced by the standards of financial reporting where the bank stands.
The main risks that can occur in ALM are: interest rate in the banking book and liquidity risk.
Interest Risk in the Banking Book
Banking book market risk: the risk of losses faced by banks to changes in market prices as a result of the bank's business structure, such as: activity and accumulation fund loans.
Interest rates in the banking book: the risk of loss due to changes in interest rates, generally the result of the bank conducted business with commercial and retail customers.
Interest risk in the banking book are not tercover in detail on Basel II. But in July 2004, a month after the Basel Committee published the "International Convergence of Capital Measurement and Capital Standards: a Revised Framework", Basel Committee published the "Principles for the Management and Supervision of Interest Rate Risk".
Activities assets and liabilities management
ALM is not just to manage risk and stabilize the business value, but also:
- Maintaining the desired liquidity structure of the bank's business
- Other things that may affect the shape and structure of bank balance sheets
- Things that can affect the stability of income every time
There are many things that can cause it needs a balance between structure and form of a bank's balance sheet, where it is a lot to do with the problems caused by international banks that have a capital structure that is dominated by the currency of their country, but income and assets and the form of eye pasivanya Other money. This led to foreign exchange risk to the bank earnings.
ALM managers should be aware that:
- Balance of a commercial bank does not consist of assets and liabilities are stable (because there are deposits and new loans or maturing)
- Repricing assets and liabilities on the bank's balance sheet is not always contractual (often there is a significant time difference between the market price changes and changes in interest rates applied to customers)
- Almost no correlation between retail product and wholesale prices to assess the assets and liabilities (a lot of marketing issue, which affects the assessor retail product but does not affect wholesale products)
- Retail products often things that are not rational (retail customers often have the right to decide the contract in different conditions than the wholesale market)
Some of the reasons why commercial banks with a number of retail customers are more difficult to manage the form and structure of its balance sheet, such as:
- Commercial banks usually consider good relations with customers, not only based on just kontral → customer focused
- Features of retail products are often different from the wholesale products that are hard to sell products in the wholesale market or difficult to manage risks by using wholesale products
Tuesday, December 22, 2009
Thursday, December 17, 2009
The Nature Of Treasury Risk
Treasury Risk is defined as the risk of loss on the bank treasury activities that depend on the risk management function of the treasury itself. Generally include the role of treasury risk management such as interest rate risk in the banking book and liquidity risk.
In practice includes treasury functions of the bank's trading activities themselves, so it is excluded in the definition of treasury risk. At some banks trading activities divorced from financing activities and liquidity management. Treasury model is called the 'Corporate Treasury'.
Actual role of the Treasury (although if the treasury is not included in trading activity) depends on the business model does. Example: Treasury may also manage the risk as the exchange rate risk from subsidiaries abroad, both in the profit and loss and capital management.
So that the Treasury can manage the risks, but the discussion was:
- Interest rate risk in the banking book → form of market risk in the banking book of the most common
- Liquidity Risk
- Management of capital / Capital Management
In practice includes treasury functions of the bank's trading activities themselves, so it is excluded in the definition of treasury risk. At some banks trading activities divorced from financing activities and liquidity management. Treasury model is called the 'Corporate Treasury'.
Actual role of the Treasury (although if the treasury is not included in trading activity) depends on the business model does. Example: Treasury may also manage the risk as the exchange rate risk from subsidiaries abroad, both in the profit and loss and capital management.
So that the Treasury can manage the risks, but the discussion was:
- Interest rate risk in the banking book → form of market risk in the banking book of the most common
- Liquidity Risk
- Management of capital / Capital Management
Saturday, December 12, 2009
Mark to Market Process
Because the trade position is always changing all the time, it is important that the bank's senior management has clear procedures regarding the mark-to-market traders to monitor performance.
Mark-to-market is a daily process in which a department (which is independent from the traders), obtain and verify the market price for all instruments in the trading book. For markets where trading is done directly with the opposition, closing price obtained from brokers active in the market, independent of the bank and find out current market price.
Some prices can be obtained from the official fixing rates such as LIBOR is determined daily (by the British Bankers' Association in London). This rate is used as a reference for many derivatives contracts as well as historical analysis.
In addition to brokers and official fixing, closing rates for some instruments obtained from official exchanges. Example:
- The closing price of shares determined by the stock exchanges where the shares traded.
- Futures contracts and options for future trading at future exchanges around the world. Each stock's closing price of each set should be used to re-evaluate all positions. Futures contracts are traded for interest rates, foreign exchange, bonds, komodiri, energy and stock index.
Procedure mark-to-market procedure consists of finding and verifying the price and put it into the bank revaluation system. The system will calculate the value of each instrument to be recorded on the bank's balance sheet. Current replacement value is also called value because they reflect the value that will pay the bank if the bank intended to make transactions at current market prices. Often the system also calculates the current risk positions resulting from the instruments which were revalued, or can be produced by a system of its own risks.
Current value of a transaction is used for:
- The calculation of profit - and loss - by comparing current values against original values
- The calculation of counterparty credit risk - by analyzing the current values of all transactions with the same counterparty (see chapter 2)
- Calculation of collateral for OTC transactions - count the current value of the instrument which is used as collateral to ensure that collateral mencover exposures from counterparty
- Margin calls by future exchanges are based on current market value. 'Margin' is the same as collateral payments on OTC transactions
- Cash settlement instruments - the end of the market value is used to complete the transaction with the counterparty
Mark-to-market is a daily process in which a department (which is independent from the traders), obtain and verify the market price for all instruments in the trading book. For markets where trading is done directly with the opposition, closing price obtained from brokers active in the market, independent of the bank and find out current market price.
Some prices can be obtained from the official fixing rates such as LIBOR is determined daily (by the British Bankers' Association in London). This rate is used as a reference for many derivatives contracts as well as historical analysis.
In addition to brokers and official fixing, closing rates for some instruments obtained from official exchanges. Example:
- The closing price of shares determined by the stock exchanges where the shares traded.
- Futures contracts and options for future trading at future exchanges around the world. Each stock's closing price of each set should be used to re-evaluate all positions. Futures contracts are traded for interest rates, foreign exchange, bonds, komodiri, energy and stock index.
Procedure mark-to-market procedure consists of finding and verifying the price and put it into the bank revaluation system. The system will calculate the value of each instrument to be recorded on the bank's balance sheet. Current replacement value is also called value because they reflect the value that will pay the bank if the bank intended to make transactions at current market prices. Often the system also calculates the current risk positions resulting from the instruments which were revalued, or can be produced by a system of its own risks.
Current value of a transaction is used for:
- The calculation of profit - and loss - by comparing current values against original values
- The calculation of counterparty credit risk - by analyzing the current values of all transactions with the same counterparty (see chapter 2)
- Calculation of collateral for OTC transactions - count the current value of the instrument which is used as collateral to ensure that collateral mencover exposures from counterparty
- Margin calls by future exchanges are based on current market value. 'Margin' is the same as collateral payments on OTC transactions
- Cash settlement instruments - the end of the market value is used to complete the transaction with the counterparty
Monday, December 7, 2009
Option Pricing
Option pricing is based on the probability of an option will have value at maturity. The main key of the option value is:
- Compare the strike price with the current market price. If the same, diekspektasikan option has a chance to 50% diexercise, because there are equal chances whether the exchange rate or an increase on the due date
- Term time. The longer the period the higher the premium because the longer time required by the option to have value. The longer period of time → higher risk
- Market price volatility. The more volatile the market price of the higher premium.
Strike price and option period chosen by the buyer. Volatility is a statistical calculation can be obtained from the historical price movements. Since the history data is not always a good predictor for the future, the expected volatility using market rates. Bervaraisi depending Volatilitias maturity and described as a curve with the same period as the yield curve.
- Compare the strike price with the current market price. If the same, diekspektasikan option has a chance to 50% diexercise, because there are equal chances whether the exchange rate or an increase on the due date
- Term time. The longer the period the higher the premium because the longer time required by the option to have value. The longer period of time → higher risk
- Market price volatility. The more volatile the market price of the higher premium.
Strike price and option period chosen by the buyer. Volatility is a statistical calculation can be obtained from the historical price movements. Since the history data is not always a good predictor for the future, the expected volatility using market rates. Bervaraisi depending Volatilitias maturity and described as a curve with the same period as the yield curve.
Wednesday, December 2, 2009
Bonds, Equities, Commodities and Foreign Exchange
- Bonds, stocks, spot foreign exchange and commodity spot judged by the difference between the original value of the traded market price at the moment.
- Forward was created by adjusting the current spot rate with the corresponding forward margins. The average margin can be calculated by the following formula:
Forward margin = Spot x Interest Differential x Time / (Days in year x 100)
o Interest Differential is the absolute difference between the base currency with foreign currency
o Time is a period of time (in days)
o Days in year = 360
- Forward margin:
actively traded on the interbank market
have quoted the standard margin for the period as the yield curve
Margins for the period in addition to the standard is obtained by interpolation
Forward assessed by comparing the original margin of the current margin.
- Forward was created by adjusting the current spot rate with the corresponding forward margins. The average margin can be calculated by the following formula:
Forward margin = Spot x Interest Differential x Time / (Days in year x 100)
o Interest Differential is the absolute difference between the base currency with foreign currency
o Time is a period of time (in days)
o Days in year = 360
- Forward margin:
actively traded on the interbank market
have quoted the standard margin for the period as the yield curve
Margins for the period in addition to the standard is obtained by interpolation
Forward assessed by comparing the original margin of the current margin.
Thursday, November 26, 2009
Pricing
One important control is to ensure that the bank's trading positions assessed every day with the current market price → is called marking-to-market.
Yield Curve
- All financial instruments with future cash flow assessed by calculating the present value of cash flow that will be due on these instruments.
- Present value is calculated by discounting the future value using current interest → interest rates on the market are needed cash flow.
- To calculate the required market rate banks create a yield curve. Curve that is used by a trader is more complex and results from several instruments to ensure that the curve is consistent.
- Rate for a standard tempo jateuh (1, 2, 3, 6, 12 months and 2, 3, 5 years) can be observed from the curve but the rate for another time to enter rate is calculated by → perform interpolation.
- The value of products related to interest rates and all the products with cash flow in the future are sensitive to changes depending on the maturity curve and financial nature of the instrument.
- In practice, each of the major currencies have a number of yield curve that is used at the same time. The differences arise mainly from differences in the basic instrument used to create discrete points.
- The main type of interest rate-related yield curves are:
o Cash - this curve is used to re-assess their positions and fund loans. Point on the curve is determined by the standard maturity traded in the interbank market.
o Derivative - this curve is used to assess all types of derivatives, including options. Point on the curve is determined by a combination of instruments starting from the cash rate by a short maturity followed by a future contract. Finally, long term rates resulting from the swap rate for the standard trading period. The combination instrument is closely related to the basic instrument used to perform the derivatives risk hedger
o Bond - bond prices are assessed based on closing price on that day. However, some bonds are not actively traded or not traded every day. For the current bonds, closing price curve can be generated from the bond (bond curve). The curves are generated from a standard maturity traded in the government bond market. Bonds can be considered as a spread over government bonds (benchmark) when market prices are not available. This reflects differences oblogasi liquidity and credit standing of the issuer.
o Base - This curve was created to determine the price of instruments that are not actively traded on the interbank market, for example: rates set by central banks for discounting bills or the Base Rate in the UK. Curve generally shows a spread above or below the standard curve. Each point on the curve has the interest rate differential alone to mature on the standard curve.
Yield Curve
- All financial instruments with future cash flow assessed by calculating the present value of cash flow that will be due on these instruments.
- Present value is calculated by discounting the future value using current interest → interest rates on the market are needed cash flow.
- To calculate the required market rate banks create a yield curve. Curve that is used by a trader is more complex and results from several instruments to ensure that the curve is consistent.
- Rate for a standard tempo jateuh (1, 2, 3, 6, 12 months and 2, 3, 5 years) can be observed from the curve but the rate for another time to enter rate is calculated by → perform interpolation.
- The value of products related to interest rates and all the products with cash flow in the future are sensitive to changes depending on the maturity curve and financial nature of the instrument.
- In practice, each of the major currencies have a number of yield curve that is used at the same time. The differences arise mainly from differences in the basic instrument used to create discrete points.
- The main type of interest rate-related yield curves are:
o Cash - this curve is used to re-assess their positions and fund loans. Point on the curve is determined by the standard maturity traded in the interbank market.
o Derivative - this curve is used to assess all types of derivatives, including options. Point on the curve is determined by a combination of instruments starting from the cash rate by a short maturity followed by a future contract. Finally, long term rates resulting from the swap rate for the standard trading period. The combination instrument is closely related to the basic instrument used to perform the derivatives risk hedger
o Bond - bond prices are assessed based on closing price on that day. However, some bonds are not actively traded or not traded every day. For the current bonds, closing price curve can be generated from the bond (bond curve). The curves are generated from a standard maturity traded in the government bond market. Bonds can be considered as a spread over government bonds (benchmark) when market prices are not available. This reflects differences oblogasi liquidity and credit standing of the issuer.
o Base - This curve was created to determine the price of instruments that are not actively traded on the interbank market, for example: rates set by central banks for discounting bills or the Base Rate in the UK. Curve generally shows a spread above or below the standard curve. Each point on the curve has the interest rate differential alone to mature on the standard curve.
Saturday, November 21, 2009
Forward Rate Agreement (FRA) and Option Contract
FRA is the OTC derivatives that allow banks to take a position on the forward interest rates.
- The contract gives the right to borrow / lend funds at a fixed rate for a certain period begins at a later date.
- No exchange or the principal amount
- The maturity of the cash settlement is the difference between the rate of the contract with the LIBOR rate prevailing at the time.
FRA is the OTC version of the interest rate futures contracts and more flexible than the future. FRA raises interest rate risk
Option Contract
- Providing the right (but not the obligation) to customers to make transactions under the contracts at the agreed price → means that the transaction will not be executed if the rate is not attractive to the customer / buyer.
- The seller has the open-ended risk of the contract and receive a premium as compensation.
- Option can be made of all cash and derivative instruments, there is even the option to option.
- The main term to describe the option is:
o Call - a call option gives the buyer the right to buy the underlying instrument
o Put - put option gives the buyer the right to sell the underlying instrument
o Premium - the amount paid to the seller by the buyer
o Strike Price - the price where the transaction will be done
o Exercise - run the option buyer to enter into a contract
o Expiry date - last date which the option must be done
o American - option that can be done on every day until the due date
o European - that option can only be done on the due date
- Determination of option pricing is based on the possibility of the option is implemented. To calculate the value of the option, use the calculation of volatility. Volatility of prices is that market prices reflect market expectations of how much prices will move in both directions during the option period.
- Option risks inherent in the instrument basically happens when the option is. Option also has a volatility risk and interest rate risk because the date of execution occur in the future. Example: option on a bond have the same risk as the risk of bonds and the risk of changes in the volatility of the oblogasi.
- The contract gives the right to borrow / lend funds at a fixed rate for a certain period begins at a later date.
- No exchange or the principal amount
- The maturity of the cash settlement is the difference between the rate of the contract with the LIBOR rate prevailing at the time.
FRA is the OTC version of the interest rate futures contracts and more flexible than the future. FRA raises interest rate risk
Option Contract
- Providing the right (but not the obligation) to customers to make transactions under the contracts at the agreed price → means that the transaction will not be executed if the rate is not attractive to the customer / buyer.
- The seller has the open-ended risk of the contract and receive a premium as compensation.
- Option can be made of all cash and derivative instruments, there is even the option to option.
- The main term to describe the option is:
o Call - a call option gives the buyer the right to buy the underlying instrument
o Put - put option gives the buyer the right to sell the underlying instrument
o Premium - the amount paid to the seller by the buyer
o Strike Price - the price where the transaction will be done
o Exercise - run the option buyer to enter into a contract
o Expiry date - last date which the option must be done
o American - option that can be done on every day until the due date
o European - that option can only be done on the due date
- Determination of option pricing is based on the possibility of the option is implemented. To calculate the value of the option, use the calculation of volatility. Volatility of prices is that market prices reflect market expectations of how much prices will move in both directions during the option period.
- Option risks inherent in the instrument basically happens when the option is. Option also has a volatility risk and interest rate risk because the date of execution occur in the future. Example: option on a bond have the same risk as the risk of bonds and the risk of changes in the volatility of the oblogasi.
Monday, November 16, 2009
Interest Rate Swap and Currency Swap
Interest Rate Swaps are OTC derivatives that allow banks and borrowers to access long-term interest rates without having a long-term funds. The main barriers for banks to provide long-term funds is credit risk and liquidity needs, while many clients have long-term projects that require long-term pendanan with fixed rate. Interest rate swap is a solution because it allows both parties to swap interest rate swap without doing the amount of principal.
Interest rate swaps are traded to maturity 30 years (although only traded a little bit above 10 years). The maximum maturity depending on the currency and bond markets in the relevant currency, because the bonds used to hedge the swap.
Vanilla interest rate swap has a fix that was'swap 'on the floating rate index such as 1 month, 3 month or 6 month LIBOR → means that all parties agree to exchange the difference in these two interest rates. Because LIBOR rate changes every time the net exchange will differ from time to time.
Interbank market trading in the market especially vanilla swap but there are many variations to meet customer needs. Interest rate swap raises interest rate risk. Banks use various hedging instruments to manage interest rate risk.
Characteristics similar to interest rate swaps, except that the flow rate is in a different currency, for example: U.S. Dollar-euro interest flows to flows.
The main difference with the interest rate swap:
Interest Rate Swap
- No subject is transferred
- Raises the risk of interest rate
Currency Swap
- Essential in the transfer / on-the spot exchange rate
- Raises the risk of interest rates and exchange rates
Interest rate swaps are traded to maturity 30 years (although only traded a little bit above 10 years). The maximum maturity depending on the currency and bond markets in the relevant currency, because the bonds used to hedge the swap.
Vanilla interest rate swap has a fix that was'swap 'on the floating rate index such as 1 month, 3 month or 6 month LIBOR → means that all parties agree to exchange the difference in these two interest rates. Because LIBOR rate changes every time the net exchange will differ from time to time.
Interbank market trading in the market especially vanilla swap but there are many variations to meet customer needs. Interest rate swap raises interest rate risk. Banks use various hedging instruments to manage interest rate risk.
Characteristics similar to interest rate swaps, except that the flow rate is in a different currency, for example: U.S. Dollar-euro interest flows to flows.
The main difference with the interest rate swap:
Interest Rate Swap
- No subject is transferred
- Raises the risk of interest rate
Currency Swap
- Essential in the transfer / on-the spot exchange rate
- Raises the risk of interest rates and exchange rates
Wednesday, November 11, 2009
Derivative Instruments
Derivatives have become a major component of market risk for more than 20 years because banks continue to create innovative products to its customers. Previous products called "cash instruments" because it is the basic instrument for derivative products.
The main characteristic of the principal amount of derivatives transactions is not traded, thus reducing the credit risk and settlement risk. Derivatives are often called 'contracts for difference' because that is exchanged is a change from the cash price of the traded instrument. Because credit risk is reduced, then the banks can trade derivatives with a lot of cash compared to the instrument, so that makes markets more liquid and the resulting growth in trading volume and the amount of risk taken by banks.
Some derivatives are traded on futures exchanges and options traded on the over-the-counter (OTC) market. OTC market is a market where banks trade directly with each other and not through the stock.
One of the important derivatives are future contracts. These contracts are traded through exchanges which act as a clearinghouse for all parties. Therefore, banks do not have to deal with credit risk from many parties, but only with the stock alone. Future contracts are deals to be done on the basic instrument in the future. There are future contracts for most of the cash instruments ranging from bonds to commodities.
In general, future contract has the characteristics:
- Exchange traded → traded through the stock
- Value of fixed per-contract
- Date of delivery has been established
- Terms of delivery must be appropriate
- Daily margin calls
Future contract risk as instruments are essentially features and interest rate risk because the transaction date in the future.
The main characteristic of the principal amount of derivatives transactions is not traded, thus reducing the credit risk and settlement risk. Derivatives are often called 'contracts for difference' because that is exchanged is a change from the cash price of the traded instrument. Because credit risk is reduced, then the banks can trade derivatives with a lot of cash compared to the instrument, so that makes markets more liquid and the resulting growth in trading volume and the amount of risk taken by banks.
Some derivatives are traded on futures exchanges and options traded on the over-the-counter (OTC) market. OTC market is a market where banks trade directly with each other and not through the stock.
One of the important derivatives are future contracts. These contracts are traded through exchanges which act as a clearinghouse for all parties. Therefore, banks do not have to deal with credit risk from many parties, but only with the stock alone. Future contracts are deals to be done on the basic instrument in the future. There are future contracts for most of the cash instruments ranging from bonds to commodities.
In general, future contract has the characteristics:
- Exchange traded → traded through the stock
- Value of fixed per-contract
- Date of delivery has been established
- Terms of delivery must be appropriate
- Daily margin calls
Future contract risk as instruments are essentially features and interest rate risk because the transaction date in the future.
Friday, November 6, 2009
Trading Instrument - Cash Instruments
There are various instruments tiger trade, where products are instruments commonly traded internationally or called 'vanilla product', because they are a pure form. The main currencies traded was USD, EUR, JPY and GBP.
Cash instruments
Spot foreign exchange transactions
Spot transactions are foreign exchange transactions for the next 2 days or it is called date spot. 2-day period arising from interbank settlemen instructions to use the telegraph and the bank took 2 days to ensure that the instructions can be executed. The market for spot transactions is the most liquid market in the world. Transactions spot foreign exchange risk caused.
Forward foreign exchange transaction
Forward transactions are foreign exchange transactions on the date specified is longer than the spot date and not more than 1 year (but there are banks that transact more than 1 year) transaction Forward exchange rate and lead to interest rate risk, because of the forward rate is determined by the level of interest rates of two currencies, combined with the current spot rate.
Foreign exchange rate swap
Swap is a combination of spot and forward. The two parties conduct spot transactions in the spot rate and forward to the forward at the same rate to the principal amount and the same currency. The difference of the two rates reflects the difference between the interest rate of 2 currency transactions during that period. Raises interest rate swap risk.
Loans and deposits
Loans and deposits traded between banks (interbank money market) at a fixed rate for a certain period. Period of time varies from overnight to 5 years, but rarely deals with maturity> 1 year. Interest paid at maturity together with the payment of principal, unless the maturity> 1 year of interest payments made each year. Interbank money market used by banks to take positions in anticipation of interest rate movements. But many bank transactions due to the need to match the funding needed to maintain their liquidity positions. Loans and deposits lead to interest rate risk.
Bonds
Bonds are long-term debt that can dipindahtangan and published by the borrower (issuer) when receiving money from the investor (holder). Bond issuer must pay interest, usually in a regular, long term bonds and to pay principal at maturity.
'Vanilla' bond usually has a fixed interest rate called the 'coupon', which will dibayatkan on a predetermined date for a period of paid bonds and principal at maturity. The term vanilla is used to indicate bonds that have a standard feature. However, bonds may have financial incentives to attract investors vary.
Bond prices are influenced by interest rates and financial condition of the issuer. Rating agencies like Moody's and S & P yield grade which covers a broad credit risk from bonds, from AAA (issuer's ability to pay principal and interest is very strong) to D (there are arrears / default). Bond raises general interest rate risk and specific risk. Non-vanilla bonds will lead to other types of risks such as liquidity risk.
Equity trading
Equity trading is the buying and selling shares of a company on the stock exchanges around the world. Shareholders will receive a regular dividend, paid out of corporate profits and rising stock values. The stock price reflects the market perception of the value of the company and the value of the projection pendaptan. Stock prices if the market fluctuates to adjust the assessment of the company as a response to information received about the company. Position led to general equity shares risk and specific risk.
Commodity trading
Commodity trading is the buying and selling physical products that are traded on the secondary market. The products include: agricultural products, oil and precious metals. Products purchased and sold to be sent to a specified location on a predetermined date. There are spot and forward markets for many products and each product has additional features that are directly related to the physical nature of the product.
Examples of product-specific feature is the oil trade.
Besides crude oil, a product of refining crude oil traded on the market. Each product has its own market and price.
Location is very important to the buyer. Sebuat crude oil tankers in the U.S. has a different value to buyers in the USA than tankers in Malaysia due to differences in demand / supply balance in each State and the oil transportation costs between countries. .
Commodity position risk and caused commodity forward position raises interest
Cash instruments
Spot foreign exchange transactions
Spot transactions are foreign exchange transactions for the next 2 days or it is called date spot. 2-day period arising from interbank settlemen instructions to use the telegraph and the bank took 2 days to ensure that the instructions can be executed. The market for spot transactions is the most liquid market in the world. Transactions spot foreign exchange risk caused.
Forward foreign exchange transaction
Forward transactions are foreign exchange transactions on the date specified is longer than the spot date and not more than 1 year (but there are banks that transact more than 1 year) transaction Forward exchange rate and lead to interest rate risk, because of the forward rate is determined by the level of interest rates of two currencies, combined with the current spot rate.
Foreign exchange rate swap
Swap is a combination of spot and forward. The two parties conduct spot transactions in the spot rate and forward to the forward at the same rate to the principal amount and the same currency. The difference of the two rates reflects the difference between the interest rate of 2 currency transactions during that period. Raises interest rate swap risk.
Loans and deposits
Loans and deposits traded between banks (interbank money market) at a fixed rate for a certain period. Period of time varies from overnight to 5 years, but rarely deals with maturity> 1 year. Interest paid at maturity together with the payment of principal, unless the maturity> 1 year of interest payments made each year. Interbank money market used by banks to take positions in anticipation of interest rate movements. But many bank transactions due to the need to match the funding needed to maintain their liquidity positions. Loans and deposits lead to interest rate risk.
Bonds
Bonds are long-term debt that can dipindahtangan and published by the borrower (issuer) when receiving money from the investor (holder). Bond issuer must pay interest, usually in a regular, long term bonds and to pay principal at maturity.
'Vanilla' bond usually has a fixed interest rate called the 'coupon', which will dibayatkan on a predetermined date for a period of paid bonds and principal at maturity. The term vanilla is used to indicate bonds that have a standard feature. However, bonds may have financial incentives to attract investors vary.
Bond prices are influenced by interest rates and financial condition of the issuer. Rating agencies like Moody's and S & P yield grade which covers a broad credit risk from bonds, from AAA (issuer's ability to pay principal and interest is very strong) to D (there are arrears / default). Bond raises general interest rate risk and specific risk. Non-vanilla bonds will lead to other types of risks such as liquidity risk.
Equity trading
Equity trading is the buying and selling shares of a company on the stock exchanges around the world. Shareholders will receive a regular dividend, paid out of corporate profits and rising stock values. The stock price reflects the market perception of the value of the company and the value of the projection pendaptan. Stock prices if the market fluctuates to adjust the assessment of the company as a response to information received about the company. Position led to general equity shares risk and specific risk.
Commodity trading
Commodity trading is the buying and selling physical products that are traded on the secondary market. The products include: agricultural products, oil and precious metals. Products purchased and sold to be sent to a specified location on a predetermined date. There are spot and forward markets for many products and each product has additional features that are directly related to the physical nature of the product.
Examples of product-specific feature is the oil trade.
Besides crude oil, a product of refining crude oil traded on the market. Each product has its own market and price.
Location is very important to the buyer. Sebuat crude oil tankers in the U.S. has a different value to buyers in the USA than tankers in Malaysia due to differences in demand / supply balance in each State and the oil transportation costs between countries. .
Commodity position risk and caused commodity forward position raises interest
Tuesday, October 20, 2009
Product Development
Complex trading activities if:
- The market becomes more liquid and sophisticated
- Banks need to trade the portfolio of instruments more than the customer needs
This prompted the bank to expand its trading portfolio. In these circumstances is very important for banks to consider the control structure to ensure that they are able to manage the risks arising from such trading activity.
Because the bank supervisor procedure provides for freedom of new products, it is important to establish a bank banks granting permission procedures are strict in the entire department of the bank. Procedures for granting a permit must include the following:
- Provision granting permission - whether a bank has a license for a product?
- Impact on capital - how these products affect the capital requirements of banks?
- Taxes - the product will create new tax issues?
- Accounting procedures - whether the product can be accommodated by the bank's procedures?
- Legal procedures and documentation - whether the provisions of law have been met and approved the document?
- IT System-does trade and settlement systems need upgrades?
- Operations - whether the bank can booked and conduct accurate transaction settlement?
- Reporting of risk management - whether the system can find the bank's risk and risk positions melaporan generated by the product?
- Pricing and valuation - whether the procedure price and mark-to-market have been approved?
- The need for funding - whether the product a significant impact on bank funding needs?
- Implications for credit risk - whether the bank has sufficient credit lines to support the product?
- Procedure compliance - whether the product requires a new compliance procedures?
- The market becomes more liquid and sophisticated
- Banks need to trade the portfolio of instruments more than the customer needs
This prompted the bank to expand its trading portfolio. In these circumstances is very important for banks to consider the control structure to ensure that they are able to manage the risks arising from such trading activity.
Because the bank supervisor procedure provides for freedom of new products, it is important to establish a bank banks granting permission procedures are strict in the entire department of the bank. Procedures for granting a permit must include the following:
- Provision granting permission - whether a bank has a license for a product?
- Impact on capital - how these products affect the capital requirements of banks?
- Taxes - the product will create new tax issues?
- Accounting procedures - whether the product can be accommodated by the bank's procedures?
- Legal procedures and documentation - whether the provisions of law have been met and approved the document?
- IT System-does trade and settlement systems need upgrades?
- Operations - whether the bank can booked and conduct accurate transaction settlement?
- Reporting of risk management - whether the system can find the bank's risk and risk positions melaporan generated by the product?
- Pricing and valuation - whether the procedure price and mark-to-market have been approved?
- The need for funding - whether the product a significant impact on bank funding needs?
- Implications for credit risk - whether the bank has sufficient credit lines to support the product?
- Procedure compliance - whether the product requires a new compliance procedures?
Thursday, October 15, 2009
Position Management and Hedging
Market risk does not only occur in trading book but also in the banking book, because the position of the banking book valued exchange rate and the current commodity value. Management interest rates in the banking book is usually done by the Treasury.
Manajem market risk in banking book done by the Treasury the right to take a position until the limit set by the bank. This activity should be strictly controlled and independently to ensure knowing the risks.
Traders manage risk by trading in instruments that match their risk position. This method is not always profitable, so that frequently used hedging techniques. Traders can hedge their risk by taking the right position on the instrument being traded, or on different instruments. These instruments can have different characteristics but the change in market value will reflect the original transaction, so for all dihedge portfolio at the market price changes will result in little or no change in market value of the portfolio. Often a transaction must be some kind of hedge to match.
Trader will conduct hedge with a more liquid instrument of instruments that are traded so that they can perform faster hedgingnya strategy, dealing addition cost would be cheaper for a more liquid market.
The advantage of derivatives (hedging) from cash instruments (such as loans):
- Lower credit risk
- Lower funding needs
- A lower capital charge
- Greater liquidity
- Dealing a lower cost
However, hedging management requires a more careful because the instruments used are not the same as original transaction. There will be some residual risk that is not to be counted tercover and controlled. In a large trading positions, the interaction between hedge and long risk positions can create new risks.
Basis risk is the residual risk of the most significant and occurs in the portfolio with the same transaction. Basis risk is the risk of change in the relationship between the price at the position and price risk instruments used to hedge the risk position. This risk occurs in situations where the market price for each type of instrument has a different but interconnected.
Manajem market risk in banking book done by the Treasury the right to take a position until the limit set by the bank. This activity should be strictly controlled and independently to ensure knowing the risks.
Traders manage risk by trading in instruments that match their risk position. This method is not always profitable, so that frequently used hedging techniques. Traders can hedge their risk by taking the right position on the instrument being traded, or on different instruments. These instruments can have different characteristics but the change in market value will reflect the original transaction, so for all dihedge portfolio at the market price changes will result in little or no change in market value of the portfolio. Often a transaction must be some kind of hedge to match.
Trader will conduct hedge with a more liquid instrument of instruments that are traded so that they can perform faster hedgingnya strategy, dealing addition cost would be cheaper for a more liquid market.
The advantage of derivatives (hedging) from cash instruments (such as loans):
- Lower credit risk
- Lower funding needs
- A lower capital charge
- Greater liquidity
- Dealing a lower cost
However, hedging management requires a more careful because the instruments used are not the same as original transaction. There will be some residual risk that is not to be counted tercover and controlled. In a large trading positions, the interaction between hedge and long risk positions can create new risks.
Basis risk is the residual risk of the most significant and occurs in the portfolio with the same transaction. Basis risk is the risk of change in the relationship between the price at the position and price risk instruments used to hedge the risk position. This risk occurs in situations where the market price for each type of instrument has a different but interconnected.
Saturday, October 10, 2009
Development of Trading Activities
The purpose of a bank to buy and sell financial instruments is to obtain short-term profits from market price movements → means the bank at risk for loss if the value of financial instruments are down.
Banks may adopt one of three trading strategies:
1. Matched Book → lowest market risk
Bank to match the customer's position directly on the same amount and opposite positions are traded both internally and with other banks → terhadi at risk only when the deal with customers and transact offset (or is called 'hedging' or 'covering' transactions).
2. Manage product positioning by making appropriate hedging or covering from the trading desk policy.
Trading desk has a limit for market risk limit the risk that belongs to the bank every time. The position can be taken because the transaction because the customer or a trader to take positions in the market. This strategy allows the trader to calculate their position to take advantage of market price movements.
3. Being a 'market maker' for a product.
Traders will give buy and sell prices to customers and other banks and memperdagangkannya at the relevant price level. This strategy is running when the market is illiquid and other market makers with whom a trader can cover the risks. Market makers can benefit from:
→ spreads between buy and sell prices
→ market information obtained from each transaction
Risk in this strategy is that the trader must take a position that can cause harm. So traders have to be disciplined in managing risk and the bank should establish and monitor a suitable limit.
Banks tend to change its strategy if the business grows and there will be more than one strategy used in the product in a bank's trading book. Usually a bank trading activities arising from the desire to provide service to customers. As the development bank's trading activities in the forex market is one of the freely traded market in the world. This comes from the introduction of floating exchange rates in the 1970s, which created new risks for customers who do international business, so they asked the bank to do forex trading for them.
The exchange rate is a retail rate offered to customers including the wholesale margin of the interbank market rate. At the beginning of a very large margin trading, but as banks increase in volume and more confident in their ability to manage their foreign exchange positions, the trading activities of the service changes to be nasbah wholesale trading operation.
The banks with lots of customers and large volume of forex transactions can use the position of 'retail' is to influence short-term movements in the forex market, and can bring opportunity to profit far exceeds the customer's transaction. That's why banks to improve your position on his trading book. When competition increases, margins will drop to the customer, so the volume of trade for the world's major currencies such as USD / EUR, USD / JPY and EUR / GBP currently dominated by interbank trade, while trade is relatively small customer.
The development of foreign exchange is a good illustration of how trade an instrument to grow in a bank.
stage 1: the bank maintains a position of the instrument match the → the bank to do deal with customers and soon to hedge with another bank. Bank profit obtained from the difference between interbank rates and the price customers
stage 2: the bank holding the position of customer transactions, waiting for a short-term market movements are profitable banks. Holding period can be extended if the bank more experienced. Bank's trading activity does not depend anymore on customer activity
Banks may adopt one of three trading strategies:
1. Matched Book → lowest market risk
Bank to match the customer's position directly on the same amount and opposite positions are traded both internally and with other banks → terhadi at risk only when the deal with customers and transact offset (or is called 'hedging' or 'covering' transactions).
2. Manage product positioning by making appropriate hedging or covering from the trading desk policy.
Trading desk has a limit for market risk limit the risk that belongs to the bank every time. The position can be taken because the transaction because the customer or a trader to take positions in the market. This strategy allows the trader to calculate their position to take advantage of market price movements.
3. Being a 'market maker' for a product.
Traders will give buy and sell prices to customers and other banks and memperdagangkannya at the relevant price level. This strategy is running when the market is illiquid and other market makers with whom a trader can cover the risks. Market makers can benefit from:
→ spreads between buy and sell prices
→ market information obtained from each transaction
Risk in this strategy is that the trader must take a position that can cause harm. So traders have to be disciplined in managing risk and the bank should establish and monitor a suitable limit.
Banks tend to change its strategy if the business grows and there will be more than one strategy used in the product in a bank's trading book. Usually a bank trading activities arising from the desire to provide service to customers. As the development bank's trading activities in the forex market is one of the freely traded market in the world. This comes from the introduction of floating exchange rates in the 1970s, which created new risks for customers who do international business, so they asked the bank to do forex trading for them.
The exchange rate is a retail rate offered to customers including the wholesale margin of the interbank market rate. At the beginning of a very large margin trading, but as banks increase in volume and more confident in their ability to manage their foreign exchange positions, the trading activities of the service changes to be nasbah wholesale trading operation.
The banks with lots of customers and large volume of forex transactions can use the position of 'retail' is to influence short-term movements in the forex market, and can bring opportunity to profit far exceeds the customer's transaction. That's why banks to improve your position on his trading book. When competition increases, margins will drop to the customer, so the volume of trade for the world's major currencies such as USD / EUR, USD / JPY and EUR / GBP currently dominated by interbank trade, while trade is relatively small customer.
The development of foreign exchange is a good illustration of how trade an instrument to grow in a bank.
stage 1: the bank maintains a position of the instrument match the → the bank to do deal with customers and soon to hedge with another bank. Bank profit obtained from the difference between interbank rates and the price customers
stage 2: the bank holding the position of customer transactions, waiting for a short-term market movements are profitable banks. Holding period can be extended if the bank more experienced. Bank's trading activity does not depend anymore on customer activity
Monday, October 5, 2009
The Nature Of Market Risk
Market risk is the risk of loss of position on and off-balance sheet due to market price movements.
Banks that have a position on the balance sheet financial instruments exposed to market risk
Banks that act as an intermediary in a transaction that is not posted on the bank's balance sheet is not exposed to market risk on these transactions
Market risk consists of:
Specific Risk → risk of price movements of securities due to factors relating to the securities or issuernya. Example: the price of a bond falls due from the issuer credit rating deteriorated → affect the bond of the issuer but does not affect the bonds in general.
General Market Risk → risk of market price movements of the entire instrument. Example: reduction in central bank interest rates caused a decrease in market interest rates, which will affect the value of all instruments related to interest rates.
General market risk is divided into 4 major categories for analysis purposes:
- Interest rate risk → potential losses due to changes in interest rates, calculated on all instruments that use one or more yield curves to calculate a market value.
- Equity position risk → potential losses due to changes in stock prices, which applied to all instruments that use stock as part of the assessment.
- Foreign exchange risk → potential losses due to exchange rate movements. This risk applies to all products and position in the exchange rate has a different value of the exchange rate used by banks in reporting.
- Commodity position risk → potential losses due to commodity price changes, apply to all commodities and derivatives.
All of the above risk categories do not stand alone because of changes in the value of a risk will affect the types of other market risks.
There are other types of market prices associated with derivatives trading, such as volatility rates, which have the same risk profile as the above categories.
The market price is influenced by several factors namely:
- Supply and demand of a product will affect the price level in the short term because the market makers adjust prices to take advantage.
- Liquidity can affect the market price
Liquid market → there are a lot of market makers and high-volume business → small profit → dealing costs for small traders.
Illiquid market → bigger profits and trade less actively
Liquid markets may become illiquid before the holiday or any announcement relating to the economy.
- Intervention by the monetary authorities can affect the market price for quick short-term.
- Arbitrage (where a market price set by one or more other market prices), will affect the daily price movements.
- Political and economic events along with natural disasters can affect the market price for a dramatic short-term (both locally and internationally).
- Underlying economic factors are the strongest drivers of long-term market prices.
Banks that have a position on the balance sheet financial instruments exposed to market risk
Banks that act as an intermediary in a transaction that is not posted on the bank's balance sheet is not exposed to market risk on these transactions
Market risk consists of:
Specific Risk → risk of price movements of securities due to factors relating to the securities or issuernya. Example: the price of a bond falls due from the issuer credit rating deteriorated → affect the bond of the issuer but does not affect the bonds in general.
General Market Risk → risk of market price movements of the entire instrument. Example: reduction in central bank interest rates caused a decrease in market interest rates, which will affect the value of all instruments related to interest rates.
General market risk is divided into 4 major categories for analysis purposes:
- Interest rate risk → potential losses due to changes in interest rates, calculated on all instruments that use one or more yield curves to calculate a market value.
- Equity position risk → potential losses due to changes in stock prices, which applied to all instruments that use stock as part of the assessment.
- Foreign exchange risk → potential losses due to exchange rate movements. This risk applies to all products and position in the exchange rate has a different value of the exchange rate used by banks in reporting.
- Commodity position risk → potential losses due to commodity price changes, apply to all commodities and derivatives.
All of the above risk categories do not stand alone because of changes in the value of a risk will affect the types of other market risks.
There are other types of market prices associated with derivatives trading, such as volatility rates, which have the same risk profile as the above categories.
The market price is influenced by several factors namely:
- Supply and demand of a product will affect the price level in the short term because the market makers adjust prices to take advantage.
- Liquidity can affect the market price
Liquid market → there are a lot of market makers and high-volume business → small profit → dealing costs for small traders.
Illiquid market → bigger profits and trade less actively
Liquid markets may become illiquid before the holiday or any announcement relating to the economy.
- Intervention by the monetary authorities can affect the market price for quick short-term.
- Arbitrage (where a market price set by one or more other market prices), will affect the daily price movements.
- Political and economic events along with natural disasters can affect the market price for a dramatic short-term (both locally and internationally).
- Underlying economic factors are the strongest drivers of long-term market prices.
Tuesday, September 29, 2009
Minimum And Actual Capital
In fact, many banks have the capital to RWA ratio in excess of provisions.
Reasons for 'excess' capital
- Capital ratio is the ratio of bank capital in which at least should not be below it. Therefore, bank management chose to keep the ratio of capital to RWA was above the minimum conditions set by the supervisor.
- In some countries like America and England, bank supervisors to set capital ratio of RWA to a specific bank. In practice this ratio over the provisions of Basel.
- Many big banks have a world of their own internal risk models, which connect the level of capital requirements for the level of risk undertaken by banks in the business portfolio. Banks then adjust their capital. Model 'Economic capital' will result in greater capital requirements than Basel II. Banks that use this model are required to disclose it in accordance with Basel II, Pillar 2.
- Basel II and economic capital of a bank's model linking a bank's capital with the level and structure of the business. Banks are commercial enterprises and management plans for both organic growth and through acquisitions, require large capital to support the bank's growth plans.
- Access to capital markets can not always be ascertained, especially in terms of cost, because it is common for banks that plan to grow to ensure that: 1) they will not be hindered by a lack of capital; 2) the benefits of their plans will not be influenced by the high cost of capital as a result of factors such as short-term market to compete with government bonds.
Reasons for 'excess' capital
- Capital ratio is the ratio of bank capital in which at least should not be below it. Therefore, bank management chose to keep the ratio of capital to RWA was above the minimum conditions set by the supervisor.
- In some countries like America and England, bank supervisors to set capital ratio of RWA to a specific bank. In practice this ratio over the provisions of Basel.
- Many big banks have a world of their own internal risk models, which connect the level of capital requirements for the level of risk undertaken by banks in the business portfolio. Banks then adjust their capital. Model 'Economic capital' will result in greater capital requirements than Basel II. Banks that use this model are required to disclose it in accordance with Basel II, Pillar 2.
- Basel II and economic capital of a bank's model linking a bank's capital with the level and structure of the business. Banks are commercial enterprises and management plans for both organic growth and through acquisitions, require large capital to support the bank's growth plans.
- Access to capital markets can not always be ascertained, especially in terms of cost, because it is common for banks that plan to grow to ensure that: 1) they will not be hindered by a lack of capital; 2) the benefits of their plans will not be influenced by the high cost of capital as a result of factors such as short-term market to compete with government bonds.
Thursday, September 24, 2009
Basel II And Capital Adequacy
Capital adequacy of Basel II is a minimum of 8% (same as Basel I), because the Committee believed that the target capital ratio of 8% for international banks are still appropriate. Because each bank to calculate capital needs are different, the actual amount will differ from the provisions of the Basel capital I.
The purpose of Basel II is to make a regulation more in line with the risk profile of each bank. 2 Committee has adopted a transition plan to ensure that Basel II will not reduce the capital requirements of a bank or the banking industry too quickly.
1. Adany multiplier to ensure that the target of a minimum capital ratio of 8% to stay awake. 'Scaling factor' will be applied uniformly to all banks using the IRB approach for credit risk or the Advanced Measurement Approach for operational risk. QIS 3 in accordance with these factors will initially set at 106%.
2. Bank supervisors may prohibit a bank to lower the capital, but the decline in bank capital should be done gradually and approved by the bank supervisors from the year 2005 - 2008
The purpose of Basel II is to make a regulation more in line with the risk profile of each bank. 2 Committee has adopted a transition plan to ensure that Basel II will not reduce the capital requirements of a bank or the banking industry too quickly.
1. Adany multiplier to ensure that the target of a minimum capital ratio of 8% to stay awake. 'Scaling factor' will be applied uniformly to all banks using the IRB approach for credit risk or the Advanced Measurement Approach for operational risk. QIS 3 in accordance with these factors will initially set at 106%.
2. Bank supervisors may prohibit a bank to lower the capital, but the decline in bank capital should be done gradually and approved by the bank supervisors from the year 2005 - 2008
Saturday, September 19, 2009
Basel II And Risk Sensitivity
Breadth of Coverage
The biggest change in the extent of risk in Basel II tercover are additional operational risks. Various types of risks included in operational risk are:
transaction, execution, Business Interruption, settlement and fiduciary risks
People, poor management and inadequate supervision risks
Criminal, fraud, theft and rogue trader risks
Relationship and customer risks
Fixed cost structures, lack of resources, technology and physical assets, risks
Compliance and legal / regulatory risks
Information risk
Basel II also makes the Pillar 2 and 3 as an inseparable part of the process of determining a bank's capital ratio. Pillar 2 in bank supervisors are expected to introduce other risks faced by the possibility of a bank.
Definition of operational risk in Basel II is not comprehensive, because in reality there are significant risks that are not included are: business risk, strategic risk and reputation risk.
Depth of Coverage
Besides the broad range of risk, the Basel II risk dicover also more depth, particularly in credit risk.
Basel I
weight risk is very simple to use depending on the type of asset and the borrower (associated with country risk and the types of institutions or OECD Non-OECD.
Basel II:
weighting of risk that are used based on the quality of the debtor, and is supported by term loans and guarantees quality
allows the use of two approaches to determine the risk weighting of assets (RWA), namely:
- The Standardized Approach (change from 'grid' approach used in the Basel I → See 'Current Exposure Method and The Original Exposure Method in Chapter 2
- The Internal Rating-Based Approach
In this approach, the bank developed a grading of internal models to determine the creditworthiness of the debtor.
Both approaches have much in common with the way agencies do grading on the issuance of bonds. But the criticisms of Basel I as at least grade of credit risk, where this is in contrast with many of the grade range used by the agency.
If the bank chose IRB approach, the number of grade determined by the bank itself (but the bank supervisors have wanted at least 8 grade).
When used Standardized approach, the 'grid' of risk weight calculation in accordance with Basel I. This approach allows the grouping of inter-grade risk weight, but with the difference between the different assets, as Basel I.
The biggest change in the extent of risk in Basel II tercover are additional operational risks. Various types of risks included in operational risk are:
transaction, execution, Business Interruption, settlement and fiduciary risks
People, poor management and inadequate supervision risks
Criminal, fraud, theft and rogue trader risks
Relationship and customer risks
Fixed cost structures, lack of resources, technology and physical assets, risks
Compliance and legal / regulatory risks
Information risk
Basel II also makes the Pillar 2 and 3 as an inseparable part of the process of determining a bank's capital ratio. Pillar 2 in bank supervisors are expected to introduce other risks faced by the possibility of a bank.
Definition of operational risk in Basel II is not comprehensive, because in reality there are significant risks that are not included are: business risk, strategic risk and reputation risk.
Depth of Coverage
Besides the broad range of risk, the Basel II risk dicover also more depth, particularly in credit risk.
Basel I
weight risk is very simple to use depending on the type of asset and the borrower (associated with country risk and the types of institutions or OECD Non-OECD.
Basel II:
weighting of risk that are used based on the quality of the debtor, and is supported by term loans and guarantees quality
allows the use of two approaches to determine the risk weighting of assets (RWA), namely:
- The Standardized Approach (change from 'grid' approach used in the Basel I → See 'Current Exposure Method and The Original Exposure Method in Chapter 2
- The Internal Rating-Based Approach
In this approach, the bank developed a grading of internal models to determine the creditworthiness of the debtor.
Both approaches have much in common with the way agencies do grading on the issuance of bonds. But the criticisms of Basel I as at least grade of credit risk, where this is in contrast with many of the grade range used by the agency.
If the bank chose IRB approach, the number of grade determined by the bank itself (but the bank supervisors have wanted at least 8 grade).
When used Standardized approach, the 'grid' of risk weight calculation in accordance with Basel I. This approach allows the grouping of inter-grade risk weight, but with the difference between the different assets, as Basel I.
Monday, September 14, 2009
Development Of The Basel II Accord
Using the Consultative Committee approach to ensure that the new regulations have a positive impact. Committee issued a Consultative papers and followed by a period for consultation and revision.
Consultation period consists of a series of Quantitative Impact Studies (QIS), which some banks estimate the impact of the implementation of Basel II on the basis of the Consultative paper issued. Consultative papers and QIS has publish are:
Consultative Paper no. 1 - June 1999
QIS No. 1 - Q3/2000
Consultative Paper no. 2 - January 2001
QIS No. 2 - Q2/2001
QIS No. 2.5 - Q4/2001
QIS No. 3 - Q4/2002
Consultative Paper no. 3 - April 2003
The results of this paper is the issuance of the Basel II Accord in June 2004.
Some analysis on the QIS 3 is based on estimates because of the lack of data, so that in 2004 and 2005 several member countries of the Basel Committee issued a 'national impact study'. In Q4 2004 Committee mengelurkan materials and guidance for local bank supervisors as the basis of 'national impact study' them → study was finally called QIS 4 and run by bank supervisors in the USA and Germany.
Consultative approach used by the Basel Committee Committee based on the desire to not change the total capital of the banking industry.
Consultation period consists of a series of Quantitative Impact Studies (QIS), which some banks estimate the impact of the implementation of Basel II on the basis of the Consultative paper issued. Consultative papers and QIS has publish are:
Consultative Paper no. 1 - June 1999
QIS No. 1 - Q3/2000
Consultative Paper no. 2 - January 2001
QIS No. 2 - Q2/2001
QIS No. 2.5 - Q4/2001
QIS No. 3 - Q4/2002
Consultative Paper no. 3 - April 2003
The results of this paper is the issuance of the Basel II Accord in June 2004.
Some analysis on the QIS 3 is based on estimates because of the lack of data, so that in 2004 and 2005 several member countries of the Basel Committee issued a 'national impact study'. In Q4 2004 Committee mengelurkan materials and guidance for local bank supervisors as the basis of 'national impact study' them → study was finally called QIS 4 and run by bank supervisors in the USA and Germany.
Consultative approach used by the Basel Committee Committee based on the desire to not change the total capital of the banking industry.
Wednesday, September 9, 2009
Reason For The Development Of Basel II
Credit models - grading or options - based
The increasing use of quantitative methods by banks to calculate and report credit risk in their asset portfolios at the peak publicated Market Risk Amendment, which allows banks to use internal models to calculate the credit risk.
The development of this quantitative method provides a strong foundation for Basel II. Two problems that must be resolved before the Committee, Basel II can process.
Determining the type of 'credit model' will be allowed on Pillar 1. Committee to consider 2 alternatives:
'Full portfolio model' is a technique → option pricing model was developed by Robert Merton in determining prices and calculate the portfolio option.
'grading models' in which risk calculations are based on 'individual obligor base' and portfolio risk is the total of these individual risk → model was also used by rating agencies like S & P and Moody's. It should be noted that the Basel II uses the term 'grades' and not 'rated' even if it means the same.
At the end of the 1990 Committee decided to use a 'credit grading models'. However, there is a trend in the banking sector to use these 2 techniques together.
The extent to which quantitative techniques can be used to cover 'other risks' particularly operational risk. There are some arguments whether these risks should be included in Pillar 2 because very few banks that use quantitative calculations to compute and manage these risks. Concern of bank supervisors that the risk is very significant and if only depend on Pillar 2 will cause 'under capitalization' or 'inconsistent capitalization' of risk.
As a result Committee decided:
Include operational risk as a quantitative calculation of Pillar 1
Defining the broader operational risk but not including the risk of reputation, business and strategic.
Credit risk models in Pillar 1 is 'credit grading techniques'.
The increasing use of quantitative methods by banks to calculate and report credit risk in their asset portfolios at the peak publicated Market Risk Amendment, which allows banks to use internal models to calculate the credit risk.
The development of this quantitative method provides a strong foundation for Basel II. Two problems that must be resolved before the Committee, Basel II can process.
Determining the type of 'credit model' will be allowed on Pillar 1. Committee to consider 2 alternatives:
'Full portfolio model' is a technique → option pricing model was developed by Robert Merton in determining prices and calculate the portfolio option.
'grading models' in which risk calculations are based on 'individual obligor base' and portfolio risk is the total of these individual risk → model was also used by rating agencies like S & P and Moody's. It should be noted that the Basel II uses the term 'grades' and not 'rated' even if it means the same.
At the end of the 1990 Committee decided to use a 'credit grading models'. However, there is a trend in the banking sector to use these 2 techniques together.
The extent to which quantitative techniques can be used to cover 'other risks' particularly operational risk. There are some arguments whether these risks should be included in Pillar 2 because very few banks that use quantitative calculations to compute and manage these risks. Concern of bank supervisors that the risk is very significant and if only depend on Pillar 2 will cause 'under capitalization' or 'inconsistent capitalization' of risk.
As a result Committee decided:
Include operational risk as a quantitative calculation of Pillar 1
Defining the broader operational risk but not including the risk of reputation, business and strategic.
Credit risk models in Pillar 1 is 'credit grading techniques'.
Friday, September 4, 2009
The Three Pillars Of Regulation
Basel II is more complex than Basel I due to:
1. covers an area larger risks;
2. introduced three-tier approach;
using more complex methods of calculating risk.
Basel I → risk of credit and market risk (through the 1996 Market Risk Amendment).
Basel II operational risk → + + 'other risk' to calculate risk-based capital of a bank → (Basel II covers credit, market and operational risk).
Basel II also connects the capital of a bank directly with the risks run by banks
Basel II framework of three concepts developed through regulations known as the Three Pillars are:
Pillar 1 - minimum capital requirement is the development of standardized rules introduced in Basel I.
Pillar 2 - supervisory review of capital adequacy and internal assessment process
Pillar 3 - the implementation of 'market discipline' in an effort to strengthen transparency and encourage safe banking practices (safe) and healthy (sound).
Pillar 1 - Minimum Capital Requirement
Within Pillar 1, banks are required to calculate the minimum capital for credit risk, market risk and operational risk (development of the Basel I). For 'traded market risk' there is no change from the Market Risk Amendment in 1996. Interest rate risk in the banking book are not tercover in Pillar 1.
Pillar 2 - Supervisory Review
Pillar 2 is intended to formalize the practice of supervision by bank supervisors today. The concept of Pillar 2 have been found on the Basel I, and is intended to determine the minimum standards that can be applied according to the bank-by-bank basis. 'Supervisory Review' on Pillar 2 applied the same as that of the Federal Reserve Board (USA) and the Financial Services Authority (UK).
Supervisory reviews arranged to focus on:
Each above the minimum capital requirement according to Pillar 1 level, and
Initial actions needed to overcome the risks that will arise.
Pillar 2 also covers review of the interest rate in the banking book. Basel Committee paper "Principles for the Management and Supervision of Interest Rate Risk" which was published in July 2004 containing details of how to manage interest rate risk in the trading book.
Pillar 3 - Disclosure
Pillar Pillar 3 is about market discipline. The Bank for International Settlements (BIS) defines market discipline as a good corporate governance mechanisms of internal and external to the free market economy without government interference.
Pillar 3 is structured to:
1. help bank shareholders and market analysts;
2. increase transparency on issues such as:
Bank asset portfolios, and
The bank's risk profile
Basel I only includes Pillar 1. In practice Pillar 2 and 3 will be found in all countries, although different approaches and their application far.
Risk Coverage - credit, market, operational and other risks
Basel Committee Pillar 1 focuses on credit risk and operational while the Market Risk Amendment does not change. Pillar 1 marked the first time by dicover operational risk quantitative approach. In addition, the Basel Committee to cover 'other risks' on Pillar 2 and 3.
1. covers an area larger risks;
2. introduced three-tier approach;
using more complex methods of calculating risk.
Basel I → risk of credit and market risk (through the 1996 Market Risk Amendment).
Basel II operational risk → + + 'other risk' to calculate risk-based capital of a bank → (Basel II covers credit, market and operational risk).
Basel II also connects the capital of a bank directly with the risks run by banks
Basel II framework of three concepts developed through regulations known as the Three Pillars are:
Pillar 1 - minimum capital requirement is the development of standardized rules introduced in Basel I.
Pillar 2 - supervisory review of capital adequacy and internal assessment process
Pillar 3 - the implementation of 'market discipline' in an effort to strengthen transparency and encourage safe banking practices (safe) and healthy (sound).
Pillar 1 - Minimum Capital Requirement
Within Pillar 1, banks are required to calculate the minimum capital for credit risk, market risk and operational risk (development of the Basel I). For 'traded market risk' there is no change from the Market Risk Amendment in 1996. Interest rate risk in the banking book are not tercover in Pillar 1.
Pillar 2 - Supervisory Review
Pillar 2 is intended to formalize the practice of supervision by bank supervisors today. The concept of Pillar 2 have been found on the Basel I, and is intended to determine the minimum standards that can be applied according to the bank-by-bank basis. 'Supervisory Review' on Pillar 2 applied the same as that of the Federal Reserve Board (USA) and the Financial Services Authority (UK).
Supervisory reviews arranged to focus on:
Each above the minimum capital requirement according to Pillar 1 level, and
Initial actions needed to overcome the risks that will arise.
Pillar 2 also covers review of the interest rate in the banking book. Basel Committee paper "Principles for the Management and Supervision of Interest Rate Risk" which was published in July 2004 containing details of how to manage interest rate risk in the trading book.
Pillar 3 - Disclosure
Pillar Pillar 3 is about market discipline. The Bank for International Settlements (BIS) defines market discipline as a good corporate governance mechanisms of internal and external to the free market economy without government interference.
Pillar 3 is structured to:
1. help bank shareholders and market analysts;
2. increase transparency on issues such as:
Bank asset portfolios, and
The bank's risk profile
Basel I only includes Pillar 1. In practice Pillar 2 and 3 will be found in all countries, although different approaches and their application far.
Risk Coverage - credit, market, operational and other risks
Basel Committee Pillar 1 focuses on credit risk and operational while the Market Risk Amendment does not change. Pillar 1 marked the first time by dicover operational risk quantitative approach. In addition, the Basel Committee to cover 'other risks' on Pillar 2 and 3.
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