Overcoming challenges to active portfolio management
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Credit Portfolio Management PowerPoint PPT Presentation

2. Introduction of Portfolio Management in ABN AMRO Bank ... Portfolio Management introduced as part of the credit and capital management architecture ...

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Credit Portfolio Management

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Overcoming challenges to active portfolio management l.jpg

Overcoming Challenges To Active Portfolio Management

PRIMA, Singapore

Otbert de Jong

Head PM AP / Global Head Risk Advisory

May 14, 2004

Contents l.jpg

1. PM, Basle II, RAROC and Economic Capital

2. Introduction of Portfolio Management in ABN AMRO Bank

3. Position of PM in the Organisation

4. Definition of the PM Mandate

5. Performance Measurement

6. Organisation & Key Management Tools

7. Overcoming Challenges in Managing the Portfolio


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1. PM, Basle II, RAROC and Economic Capital

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Basle II, RAROC and Economic Capital

How does it all fit?

  • Basle II will bind regulatory capital to credit quality

  • Regulatory/Economic capital will be measured on the basis of 3 main risk factors: market risk, credit risk and operational risk as the amount of capital that will be required to support these risks

  • RAROC: Risk Adjusted Return / Economic Capital

  • Economic Profit: expands RAROC by incorporating the cost of equity capital

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Basle II, RAROC and Economic Capital

Simply put, Economic Profit is:


less:Cost (operating)



Cost of Capital

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2. Introduction of Portfolio Management in ABN AMRO Bank

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Introduction of Portfolio Management

Increase in

loan losses and






Understand true


Desire for



Bursting of Tel. &

Tech Bubbles



Capital reduction

in lending

Better Credit






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Introduction of Portfolio Management

The Loan Portfolio takes Centre Stage:

  • Need to better measure the quality and quantity of the portfolio

  • Need to better balance and “manage” the portfolio

  • Need to improve rating processes

  • Need to manage capital invested in lending business =

    leading to emphasis on economic capital vs regulatory capital

Portfolio Management introduced as part of the credit and capital management architecture

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Introduction of Portfolio Management

Major steps:

  • Positioning of Portfolio Management in the organisation

  • Definition of the mandate of PM

  • Internal buy-in

  • Data and systems

  • Definition of portfolio parameters and performance measurement

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3. Position in the organisation

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Positioning in the Organisation

Wholesale Clients

Risk / Compliance / Legal / Audit / Human Resources / TOPS

Change Management

Client Business Units





Financial Markets

Global Transaction Services

Product Business Units

Private Equity


Corporate Finance

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  • In the introduction of PM one faces 2 types of Challenges

  • 1. Self Made challenges as a consequence of

  • insufficient preparation or

  • definition of mandate => boundary battles

  • 2. Institutional challenges: inertia and change management

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4. Definition of the mandate

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PM Mandate

  • Which portfolio?

  • Decision rights (and at which stage) ?

  • Client relationship implications of making PM a profit centre?

  • Format for compensation for loss making deals?

  • Allocation of capital for investment activities?

  • Product type (loan, CDs, bonds, …)?

  • Accounting implications?

Just a few of the questions to be answered:

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PM Mandate

Portfolio Originator

PM mandate

Hedging, selling and

buying exposure,

actively managing

against portfolio


Owner of Portfolio

Portfolio Management

Both Origination and

Owner of P&L


Roles / Function


Asset Manager


Hedging and selling existing exposure to improve risk/improve diversification

PM becomes a business on its own merits

Monitoring and



Portfolio Management


Origination. PM has shadow P&L

Portfolio Management


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PM Mandate

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  • Increased efficiency and a streamlined Credit Process

  • Attention to biggest value drivers: Provisions and Economic Capital Cost

  • Stronger pricing discipline by instilling a better appreciation of Economic Capital

  • More active management of the portfolio within enhanced Portfolio Parameters

  • Increased decision rights

  • Changes in the origination behaviour

PM is responsible for managing the loan portfolio with an objective to maximise Economic Profit within a client driven wholesale bank strategy.

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PM Mandate


  • Obtained full P&L responsibility for the Loan Portfolio

  • Obtained enhanced participation on Engagement and Credit Committees

  • Introduced Shortfall Compensation Payments

  • Obtained discretionary investment rights

  • Sole discretion over asset disposals or hedges

  • Developed tools to actively manage the portfolio

PMG is responsible for managing the loan portfolio with an objective to maximise Economic Profit within a client driven wholesale bank strategy.

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5. Performance Measurement

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Performance Contract

Performance Contracts Based on Economic Profit (“EP”) and RAROC

Old P&L:

+/+ Credit Revenue

-/- Operating Expenses (direct + indirect costs)

-/- Provisions Budget

-/- Tax

-/- Capital Charge (BIS 1)

Performance EP (stand-alone basis):

+/+ Credit revenue

-/- Direct costs

-/- Provisions based on Expected Loss

-/- Tax based on a global average

-/- Capital Charge based on Econ. Capital

Alignment with other parts of the business is important !

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6. Organisation & Key Management Tools

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Organisation Portfolio Management

Portfolio Strategy/Execution

Credit Portfolio Management

Portfolio Analytics

Asia Pacific





Asia Pacific




South America




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Key Management Tools

New In

WCS Loan


Old Out

Enlargement of PM’s Mandate required enhancements to Key Management Tools

PMG FilterPortfolio Parameters

Loan Pricing Tool

  • Shortfall Compensation Programme

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PM Filter

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Loan Pricing Tool

  • Major Outputs:

  • Economic Profit


  • Benchmark Pricing

  • ROS

  • Economic Capital

  • Regulatory Capital

  • Major Inputs:

  • Credit Rating => PD

  • T & C Risk

  • LGD

  • Legal Risk

  • Collateral

  • Tenor

  • Expected Utilisation

  • Industry

  • Revenue and Opex

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Loan Pricing Tool

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Loan Pricing Tool

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Shortfall Compensation

Credit Income vs Relationship income

CPM receives compensation for Economic Loss from other product area in case of major cross sell

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Managing the Portfolio

Economic Performance:

Risk / Reward / Diversity

Industry/ Geography

Rating / Tenor









Investment Portfolio

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Minimising Provisions

(Important Value Driver)

  • move away from higher risk categories

  • historical and forward looking analysis

  • diversity: geography / industry matrix

  • use of KMV

  • active portfolio management incl. timely exit

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Cost of Capital

(Next Important Value Driver)

  • Only Economic Profit positive or min. RAROC % transactions

  • Portfolio Optimisation

  • Exit low yielding relationships

  • Augment primary business with secondary market opportunities

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Portfolio Management Instruments

Primary Origination

Purchase/Sale in Secondary Loan Markets

Hedge (insurance or credit derivative)

Selling Credit Protection

Buying /selling in bond market

Exercising put options

Risk Distribution e.g. CLO /Securitisation

Portfolio Trades

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  • Real time review and update of obligor credit ratings

  • Forward looking ratings, detect credit migration, perform stress testing

  • Model calibrations

  • Sector and geographical reviews and concentration

  • Monitoring of RAROC and EC/limits and EL/limits (monthly)

  • Data accuracy and procedure improvements

  • Early involvement in potential transactions

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8.Overcoming Challenges in Managing the Portfolio

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The universe of Portfolio Management



Relationship Banking

Audit & Compliance

Credit Markets


Other Geographies



Other Product BU’s




Risk Management


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Sources of problems

  • No buy-in / commitment by all stakeholders (see universe of PM on previous slide)

  • Incoherent formulation of mandate of PM

  • Poor execution

  • Poor or lack of supporting systems

  • Poor data quality and/or maintenance

  • Most of all: Poor communication

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Technical challenges

  • Tools: start simple and build it up. Don’t run if you can not walk

  • Measuring: quality over quantity

  • P & L : solve boundary issues quickly

  • Centralise and have specialists and “champions”

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Change Management

  • Create buy – in / commitment

  • Communicate

  • Report

  • Success breeds ……………..

  • Strategy and Determination

  • Professionalism

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Results to date

Very encouraging:

  • Marked improvement of RAROC

  • Reduction of RWA by 30+% at equal revenues

  • Big change in origination behaviour

  • Catalyst for better credit assessment and better measurement

  • Further upside in portfolio optimisation and arbitrage

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Risk Advisory Service

  • Risk Management strategic and implementation advice for Financial Institutions:


  • Support on strategic issues such as capital budgeting, capital allocation, strategic choices, systems selection, organisational change, RM implementation programs, coaching and specialist services.

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Thank you

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