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AFIAA Conference - May 2008. Basel II for smaller ADIs ICAAP Calculations Key Drivers. David Bergmark Protecht Advisory. Objectives. To Understand:. Overview of ICAAP requirements Understand what an “ICAAP” process involves
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Basel II for smaller ADIs
Under the new Basel II regime, the new APS 110 standard “Capital Adequacy” requires all ADIs to:
“have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels”
To ensure ADIs have adequate capital to support all the risks and to encourage ADIs to develop and use better risk management techniques in monitoring and managing their risks
Internal independent view of the risks of the ADI and the capital required to support them and allows APRA to compare their assessment with ADI’s
It’s the Journey, not just the Destination
APRA requires all ADIs to maintain a minimum capital ratio of 8%.
Separate PCR’s will be set for each ADI proportional to each ADIs overall risk profile
Risk weighted assets
Credit Risk (Assuming a well diversified portfolio)
Market risk for trading (N/A for Mutuals!)
Operational Risk (Direct loss effects only)
“Pillar 2 inherent risk exposures are assessed quantitatively to the extent possible but, where risks are not readily quantifiable, supervisory judgment is necessary. Supervisory judgment is also necessary with respect to qualitative assessments of the ADI’s ability to contain actual risk exposures within prudent, planned levels through effective risk governance, oversight, management and control practices.”
“Since these exposures and qualitative factors are generally not capable of quantification, or at least robust quantification, a degree of judgment about capital adequacy is required, including by supervisors”.
“Strategic risk is very difficult to quantify”
Quantitative or Qualitative?
The risk of incurring unexpected costs or losses in meeting financial obligations when they fall due.
Caused by mismatch between the contractual maturities of actual (or contingent) financial assets and liabilities.
Where contractual dates are mismatched, assumptions need to be made about the renewal / replacement of maturing liabilities, draw downs of outstanding commitments, or the ease of realising assets. These assumptions may prove incorrect. Costs may result from the forced replacement funding at higher cost or the forced realisation of assets at lower than value. The greater the mismatch, the greater the potential cost of having to generate alternative funding to cover that mismatch.
APRA will review the ADI’s liquidity risk management policies, procedures and limits, and its actual liquidity risk profile.
Everything else …… example
ICAAP Policy Document
Annual ICAAP Document - Documentation of the process
Risk Assessment Questionnaire
Capital Plan, Strategic Plan, Business Plan, Budgets – all linked
Effective and comprehensive review of ICAAP on a regular basis
Assessment of Risk for ICAAP
Credit Concentration – Property Value
Credit Concentration – Geographic
Credit Concentration – Industry
Strategic – Business Environment
Strategic - Technology
Strategic – Economic
Contagion – Industry
Contagion – 3rd party
Liquidity – Large exposures
Liquidity – Mismatch
Liquidity – Large Deposits
Liquidity – Fund stickiness
Internal Capital Adequacy Process