Liquidity Crisis And Stress Testing

Liquidity risk cannot be treated satisfactorily by the VAR because it ignores the risk exposure of a portfolio during the process of its liquidation. A liquidity crisis is usually an extreme event, so it requires tools Stress testing more appropriate than the VaR.

To fight against liquidity crises, the scenarios of crisis of a financial institution must include all the fragility of its balance sheet, namely the possible mismatch between investments in illiquid assets and funding sources precarious liabilities. A Stress Test relevant to a financial institution would be important to consider the consequences of a simultaneous withdrawal of its market counterparties. This is the way in which JP Morgan is committed after the near-collapse of LTCM in 1998. JP Morgan has developed the "dealer exit stress tests" to estimate the risk of sudden drying up of market liquidity due to one or more of their counterparties. This kind of stress tests and allowed to become aware of the dangers of the high concentration of certain financial markets.

One of the limitations of VaR as originally calculated was based on an assumption of "normality" of events. Or rare events are more important in magnitude than the law says normal. The work was therefore directed towards the use of distributions from "fat tails". Stress Testing procedure has the advantage of circumventing this difficulty by specifying the desired magnitude of the event, regardless of its probability of occurrence. Therefore it is considered an extension of the VaR.

Although complementary, these two methods have significant differences, however, since they are far from operating in the same period. Indeed, while the VaR is a tool for highly automated daily monitoring, Stress Testing requires the intervention of a number of players and often requires a significant delay construction and analysis. Thus, if the answer to a VaR limit is exceeded is simple (just cut positions), the response to overexposure through a liquidity stress analysis is more complex (installation program or refinancing guarantees, etc.)..
Finally, unlike the VaR with the automatic calculation can facilitate the adoption of the outcome, the results of stress testing because they are developed from subjective elements, require a real effort to communicate and explain with decision-making bodies.

Market Risk Assessment -2

Using a single number, indicate the VaR of a portfolio exposure to market risk and the likelihood of loss under the conditions proposed. The risk is also measured in monetary units, the same as those in which balances are established. Finally, among its other benefits, VaR:

* To evaluate the performance and correct any risk-based.
* Promote the information and transparency to the extent that it is a measure expressed in non-technical terms and may be subject to periodic reports.
* To determine the allocation of funds to invest and set quantitative limits for risk managers.

Three calculation methods are generally used to estimate the distribution of losses. They have in common to estimate the potential change in portfolio value from the data of the past, however, differ on the following:

* The historical method: observation of the historical behavior of the position to estimate the VaR;
* The parametric method: decomposition of the position of instruments based on different risk factors (equity indices, rates of different maturities, exchange rates ...) and then estimate the probability distribution of risk factors;
* The Monte Carlo simulation Monte Carlo market factors from an a priori probability distribution and estimate the VaR, as the historical method, from the sample generated.

Market Risk Assessment -1

Quantification of risk is a major concern of financial players because it allows them to answer questions like "How can we lose with our portfolio in normal market conditions or abnormal for a time horizon given? ". VaR (Value at Risk) and Stress Testing are the two most common methods of quantification of risk and are usually combined.

Although the VaR can be used as a baseline measurement for all types of risk and the overall level of society, its most common use for market risk.
VaR is a probabilistic measure of the loss of a portfolio point of a given composition as a result of future changes in risk factors. It is defined by the maximum probable loss at a confidence level of x% (for a time horizon of one day / one week, etc.).. Var corresponds to the loss that will not be exceeded in more than (100-x)% of cases, when a position given structure is maintained for a period [0, T].

If Vt is the value of the position t, the VaR is given by:
Pr {Vo - VT} ≤ ≥ VaR (100 - x) / 100

For example, consider a portfolio for which the VaR of € 100 million with a confidence level of 99% over a period of one week, meaning that, under normal market conditions, there is a probability of 1 % to record a loss of more than € 100 million for the week of detention (period over which the change in value of the portfolio is measured).

How Bank can Control Internal Transfer Rate -4

The TCI should be calculated and stored in the SI as the implementation of the operation to be exploited in the management tools of the trade act. This would also ensure consistency of refunds to the dashboard used by senior management. Of course, this also requires a vertical integration of all impacted reference: Product size / dimension structure / customer dimension. This target is difficult to achieve in the short term, however, according to their priorities and constraints, banks can already move to intermediate systems. For example, the establishment of an exchange system between the distribution and the calculation system (ALM) would ensure the inclusion of the real characteristics in the calculation of TCI. Although the TCI is not preserved, it can be recalculated to the same using the same parameters (market data, contract data), known at the time of the request. Thus, the joint calculations a priori / a posteriori would be consistent.

Other improvements could be made to the establishment of a TCI approach. For example, the business may wish to have a global vision allowing him to integrate the risk profile of the customer in managing the commercial act.
Propose systems to measure the performance of activity based on risk and include operating costs would also be an area for improvement.

The work of coherence and sophistication will make TCI a real management tool for profitability and not just a constraint for a single measurement.

How Bank can Control Internal Transfer Rate -3

To ensure proper use and membership of teams, schools must conduct a deep reflection on their process of diffusion of ICT and develop their information and their organization to ensure consistency of refunds. The objective is to obtain a homogeneous and TCI shared by all players.

Efforts should be worn on the establishment of committees (awards committee or other governing body) that would go all the advantages / disadvantages of a product and this on all axes. Indeed it is important to highlight the difficulty or ease of marketing a product: product carrier, product not meeting customer expectations, discontinued product, but also the financial aspects: produces little or very profitable ...

This information will then be shared by all to define a more accurate pricing. The bonus / penalty that can be set up in response to market developments with a view to remain competitive in the standards of the place must be clear communication activities to facilitate their adoption. The aim is to involve all stakeholders in the pricing and impose the CIT, not as a constraint but as a guarantee of profitability indicators like credit risk.

These elements will allow policy makers to reorient trade policy or financial institution on the basis of cyclical and structural analysis while ensuring compliance with the policy set.

Course to ensure the homogeneity of the refunds should be defined processes to close the dashboard rather than in their broadcasts, but in their preparation. To do the bridges between the different functions must be implemented, supported by clear governance principles.