ERM in Financial Services - Basel 3

Question 1

How many key principles of supervisory review are there under Basel 3?

Answer 1

4

Question 2

What are the key principles of supervisory review under Basel 3?

Answer 2

1. Banks should have a process to assess their overall capital adequacy in relationship to their risk profile.
2. Supervisors should review and evaluate a bank’s internal capital adequacy assessments.
3. Supervisors should expect banks to operate above the minimum regulatory capital ratios.
4. Supervisors should intervene at an early stage to prevent capital falling below the minimum levels required.

Question 3

What the features of a rigorous capital assessment process that regulators are looking for?

Answer 3

1. Board and senior management oversight - board should set the risk appetite.
2. Sound capital assessment - Capital ratio target should be linked to bank’s business strategy and transparent link between risk and capital.
3. Comprehensive assessment of risk - all material exposures should be measured or estimated including those identified by Pillar 1 and others such as interest rate, liquidity and credit concentration risk.
4. Monitoring and reporting - system for assessing how risk changes and what affect it has on capital requirements. Also evaluate the trends of material risks and evaluate the sensitivity of risk measures.
5. Internal control review - review of internal limits and controls.

Question 4

What is involved with Pillar 2 Supervisory Review?

Answer 4

Banks should carry out their own risk and capital adequacy assessment and document it in their ICAAP submission.

Independent supervisory review of the ICAAP before determining the final capital requirements.

Question 5

What does ICAAP place an importance on?

Answer 5

• Stress testing
• Ability for the bank’s regulatory capital to absorb losses during times of stress (will the capital hold value?)
• The long term capital requirements of the bank.

Question 6

What is ORSA also known as?

Answer 6

FLAOR - Future Looking Assessment of Own Risks.

Question 7

What is the scope of ORSA

Answer 7

The entirety of the risk management system that the insurer has in effect. It assess the risks and identifies how much capital is required.

Question 8

To what minimum confidence level must the Pillar 1 Solvency 2 capital requirement be calculated to?

Answer 8

99.5% confidence level over 1 year.

Question 9

Can firms develop models that exceed this confidence level?

Answer 9

Yes

Question 10

Can ORSA include other types of risk not included in Pillar 1?

Answer 10

Yes - it can include reputational and strategic risks.

Question 11

How does a firm develop its Internal Model?

Answer 11

Input of data, assumptions, estimates.

Calculation of the capital requirements for each risk category using approved methodology.

Solvency 2 capital requirements and risk ratings are generated.

This model is used in test scenarios.

Quant testing - statistical and data quality tests and calibration test.

Validation using experience and judgement.

Review operational MI.

Compliance Review