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Strategic Asset-Liability Management for Financial Institutions

Day One

Risk Measurement and Management in ALM

Overview of ALM

  • ALM’s expanding role in managing risks and returns across the bank
  • ALM organization overview
  • Key risks managed – interest rate, liquidity, FX and credit risks
  • Strategic ALM – Use of funds transfer pricing, full transfer pricing and economic value added (EVA) to steer the balance sheet
  • ALM as a constrained optimization problem – maximizing profit subject to compliance with all regulatory and internal constraints holistically

Interest Rate Risk

  • Earnings and economic value of equity (EVE) impacts of interest rate risk (IRR)
  • Earnings-based IRR measurement models – repricing gap, maturity-adjusted repricing gap, marginal and cumulative gaps, standardized gap
  • EVE IRR measurement models – duration gap, cash flow mapping, duration intervals, modified residual life, clumping
  • IRR measurement in the trading book – VAR and expected shortfall; FRTB treatment
  • Behavioural and financial options – non-maturity deposits, pre-payments, term deposits, automatic interest rate options

Case Study 1: Deposit modelling at Barclays Plc

Case Study 2: Modelling pre-payments at Barclays Plc

  • Basis risk
  • Yield curve twist and curvature risk
  • Dynamic analysis of net interest income risk
  • Managing net interest income risk across currencies
  • Estimating asset and liability volatilities and correlations
  • IRR stress-testing and earnings-at-risk
  • IRR hedging techniques using interest rate swaps, swaptions, caps/floors/collars, futures, swap futures, forward rate agreements

Case Study 3: Use of interest rate derivatives to hedge interest rate risk on residential mortgage book

  • New BCBS standards for Interest Rate Risk in the Banking Book (IRRBB)
  • Estimating deposit interest rate elasticities

Workshop 1: Dynamic analysis of net interest income risk for a bank balance sheet and design of hedging strategy

Liquidity Risk

  • Key sources of liquidity risk – maturity mismatch, collateral posting requirements and off-balance sheet
  • LCR and NSFR
  • Liquidity stress-testing
  • Key behavioural options – deposits (demand and time); pre-payable/revolving loans; liquidity/credit facilities
  • Deposit modelling under stress – deterministic, historic and stochastic factor models

Case Study 4:  Deposit modelling under stress at Barclays Plc

  • Stressing liquidity/credit facility drawdowns – deterministic, historic and stochastic factor models

Case Study 5:  Modelling stressed liquidity/credit facility drawdowns at Deutsche Bank AG

  • Collateral management – CSAs, initial margin requirements, central clearing
  • Funding Value Adjustment (FVA) and Margin Value Adjustment (MVA)

Case Study 6: Calculating FVA and MVA

  • Stressed derivative collateral posting requirements – modelling for ratings triggers and stressed financial market conditions

Case Study 7: Stress testing collateral posting requirements for a derivatives portfolio

  • Contingency funding plan

Credit Risk

  • Key sources of credit risks – loans, bonds and counterparty credit risk
  • Expected and unexpected credit losses, including expected credit loss measurement and dynamics under IFRS 9
  • Credit value at risk
  • Using credit derivatives to manage loan book credit risk

Case Study 8: Use of CDS at Nordea to manage loan book credit risk and benefit from capital efficiency

  • Use of securitization for credit risk transfer, funding and/or capital efficiencies

Case Study 9: Use of securitization at Lloyds Banking Group Plc

  • Options for NPL management – outsourced collections; sale; creation of non-core units; securitization; EVA approach as best practice

Case Study 10: What strategies are European banks using to deal with their NPLs?

  • Counterparty credit risk – Credit value adjustment (CVA); CVA hedging; use of proxies for counterparty credit curves; new standardized approach for CVA (SA-CVA) and how best to arrange derivatives activities for CVA capital efficiency

Day Two

Strategic ALM

ALM Optimization

  • Recap of key regulatory requirements within which ALM must be conducted – Basel 3 Pillar 1 capital requirements; LCR and NSFR; leverage ratio; Pillar 2 capital and liquidity requirements; total loss absorbency capacity (TLAC) and minimum requirement for eligible liabilities requirement (MREL); various “Basel 4” components including revised standardized approach for credit risk, SMA (operational risk), SA-CVA, new market risk standard (FRTB), IRRBB and capital output floor
  • How should banks think of ALM as a constrained optimization problem to maximize earnings subject to these various regulatory requirements as well as internal risk limits

Case Study 11:  Model for ALM optimization for a hypothetical bank, compliant with all regulatory requirements and making recommendations for strategy for the constituent business units

Workshop 2: Simulating the ALM-optimized balance sheet for new business development and market risk shocks. What actions should be taken?

Collateral Management

  • Understanding Credit Support Annexes (CSAs)
  • New regulatory requirements for initial margin
  • Central clearing
  • Collateral management – rehypothecation vs. segregation; “cheapest to deliver” collateral optionality; managing the liquidity buffer composition in different stress scenarios
  • Funding Value Adjustment (FVA) as a measure of the net cost of variation margin collateral posting

Case Study 12: Calculating FVA

  • Margin Value Adjustment (MVA) as a measure of the cost of initial margin collateral posting

Case Study 13: Calculating MVA

  • Stressed derivative collateral posting requirements – modelling for ratings triggers and stressed financial market conditions
  • How should we manage the liquidity buffer?

Risks and Returns in Fair Value Portfolios

  • Strategic use of trading book and investment/available for sale portfolios
  • VAR, stressed VAR and expected shortfall frameworks for monitoring risk

Case Study 14: Fundamental Review of the Trading Book (FRTB). What does the ALCO need to be aware of?

  • Measuring returns on risks taken in fair value portfolios
  • Risk limit setting
  • ALM oversight of market risks to control capital and funding impacts

Funds Transfer Pricing. Full Transfer Pricing and Economic Value Added

  • Accurate business unit performance measurement as key to capital allocation
  • Transfer pricing broadly as the way to achieve accurate performance measurement and to steer the balance sheet
  • The need for liquidity risk pricing and funds transfer pricing (FTP) as the mechanism to do this
  • Options for calculating the FTP curve
  • Effective maturity measurement for FTP on assets and liabilities with significant behavioural elements
  • Pricing contingent liquidity risk – deposits, liquidity/credit facilities, derivatives collateral posting

Case Study 15: Implementing FTP at a predominantly retail bank

  • FTP for investment banking operations – behavioural holding periods and high contingent liquidity risks

Case Study 16: Implementing FTP at a universal bank with significant investment banking operations

  • Full transfer pricing and economic value added (EVA)

Case Study 17: What does a complete EVA framework look like?

  • Should Treasury make a profit from transfer pricing?

Day Three

Strategic ALM (Cont.)

ALM and Capital Management

  • Role of ALM in capital management
  • Regulatory vs. economic capital
  • Budgeting by business unit and firm-wide
  • Forming the capital plan in conjunction with the business plan and stress testing it for ICAAP or other purposes. What target capital range should we have?
  • Setting risk appetite and limits across the group
  • Optimizing capital issuance – capital composition choices (equity, Additional Tier 1, Tier 2 and other loss absorbency capacity) and implications for earnings and balance sheet resilience

Case Study 18: Capital planning at Barclays Plc

  • Target ratings considerations
  • Performance measurement and capital allocation across business units – EVA; returns on risk-adjusted capital; diversification; and strategic considerations

Case Study 19: EVA and capital allocation at Nordea

  • Deleveraging transactions
  • Measuring ALM performance
  • Role of ALM in capital efficiency

Derivatives Hedging in ALM

  • Derivatives hedge accounting under IFRS 9. What place for non-designated hedges with economic benefit?
  • Review of key interest rate and FX derivatives used in ALM
  • Level 2 vs. Level 3 valuation
  • Using interest rate derivatives to manage net interest income, fair value portfolios, and funding management
  • Standard vs. non-standard derivatives
  • Operational and liquidity implications
  • Enhancing income through use of derivatives
  • ALM impact of clearing derivatives through central clearers vs. bilateral margining
  • Collateral and capital implications of new derivatives regulations
  • Impacts on capital and financial performance from derivatives applications

Case Study 20: Use of cross currency interest rate swaps to hedge non-base currency own debt issuance

ALM and Funding

  • Review of funding instruments, their behaviour, costs, risks and benefits – deposits (retail, SME, large corporates); interbank; commercial paper and certificates of deposits; secured financing transactions; covered bonds; securitization; senior unsecured debt
  • Optimizing the funding mix for the business model

Case Study 21: Reconfiguring the funding mix at Paragon Banking Group Plc

  • Where is the line between capital and funding?
  • Target ratings and financial flexibility considerations
  • Developing and maintaining market access
  • Managing funding maturity profile
  • Use of derivatives in financing strategies
  • Securitization – which assets; what risk retention; tranching; capital requirements; cash flow considerations
  • Structured financing products and strategies
  • Off-balance sheet and special purpose vehicle financing

Insurance Company ALM

  • Solvency 2 efficient investment portfolio construction under the standard formula and internal model options
  • Managing interest rate risk, taking account of guarantees (at maturity, annual and clique), volatility adjustment, risk margin and transitional measures on technical provisions – the problem of the ultimate forward rate
  • Reinsurance programme design under Solvency 2
  • Balancing returns and risks in product design and mix under Solvency 2 – how to measure economic value of new business (VNB)

Case Study 22: VNB measurement at Allianz SE

  • Derivatives in insurance ALM
  • Setting the Solvency 2 ratio target range, ladder of intervention and composition of own funds

Case Study 23: Implementing Solvency 2 efficient ALM across product design, investment portfolio construction, interest rate risk management and reinsurance



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