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1、AssessingtheimpactofIDRonbank’sregulatorycapitalEduardoEpperlein&AlanSmilliePRMIA-ISDASeminar11September2007Theanalysisandconclusionssetfortharethoseoftheauthors.Citiisnotresponsibleforanystatementorconclusionherein,andopinionsortheoriespresentedhereindonotnecessarilyreflectth

2、epositionoftheinstitution.1OutlinePartI:CapitalizingMarketRisk(“therules”)PartII:ModellingIDR(“themaths”)PartIII:ImpactofIDR(“theshock”)CapitalizingMarketRisk-BackgroundIn2005BIS*requiresbankstocapitalizeTradingBookdefaultrisk“toasoundnessstandardcomparabletothatoftheIRBbasedappro

3、achtocreditrisk”ThisisIncrementalDefaultRisk(IDR)IDRmodelrequiredfornewVaRmodelapprovalsFirmswithexistingVaRmodelapproval(includesmostlargebanks)haveuntil2010toimplementIDR*“TheApplicationofBaselIItoTradingActivitiesandtheTreatmentofDoubleDefaultRisk”,BIS2005,www.bis.org/publ/bcbs

4、116.pdfCapitalizingMarketRisk–CurrentRulesBasicMarketRiskCapital=3xVaRMarket(99%,10-day)Nottooclearwhat‘3’multipliermeans,butisbroadlyacceptedbyindustryRangeofmethodstomodelVaRMarketsubjecttoregulatoryapprovalSpecificRiskSurcharge(SRS)AppliedifbanksdonotcaptureeventriskinVaRMarket

5、TotalMarketRiskCapital=Basic+SRSCapitalizingMarketRisk–TheNewStandardInterimRegulatoryIDR:VaRDefault(99.9%,1year)“toasoundnessstandardcomparabletothatoftheIRBbasedapproachtocreditrisk”InterimRegulatoryTotalCapital:VaRDefault(99.9%,1year)+3xVaRMarket(99%,10-day)SpecificRiskSurcharg

6、eisabandonedNodiversificationbetweenVaRDefaultandVaRMarketDraftrulespermittheassumptionof“constantlevelofrisk”ratherthanbuy-and-holdfor1yearmoreonthislaterCapitalizingMarketRisk–IndustryResponseTwomainconcerns:Setsafarhigherstandardfordefaultrisk(99.9%,1year,nodiversification)than

7、marketrisk(99%,10days,diversification,3multiplier)Regulatorscreatinganincentivetoignorenon-defaultriskintheTradingBookRulesprescribeperfectcorrelationbetweendefaultlossesandmarketlossesNotrealistic,failstheusetestCapitalizingMarketRisk–IndustryResponseIndustry*putforwardanalternat

8、iveproposalThecurrentrulescanbein