Bank of America 2014 Annual Report Download - page 98

96 Bank of America 2014
Reserve for Unfunded Lending Commitments
In addition to the allowance for loan and lease losses, we also
estimate probable losses related to unfunded lending
commitments such as letters of credit, financial guarantees,
unfunded bankers’ acceptances and binding loan commitments,
excluding commitments accounted for under the fair value option.
Unfunded lending commitments are subject to the same
assessment as funded loans, including estimates of probability
of default and LGD. Due to the nature of unfunded commitments,
the estimate of probable losses must also consider utilization. To
estimate the portion of these undrawn commitments that is likely
to be drawn by a borrower at the time of estimated default, analyses
of the Corporation’s historical experience are applied to the
unfunded commitments to estimate the funded EAD. The expected
loss for unfunded lending commitments is the product of the
probability of default, the LGD and the EAD, adjusted for any
qualitative factors including economic uncertainty and inherent
imprecision in models.
The reserve for unfunded lending commitments was $528
million at December 31, 2014, an increase of $44 million from
December 31, 2013. The increase was driven by increases in
expected loss.
Market Risk Management
Market risk is the risk that values of assets and liabilities or
revenues will be adversely affected by changes in market
conditions. This risk is inherent in the financial instruments
associated with our operations, primarily within our Global Markets
segment. We are also exposed to these risks in other areas of the
Corporation (e.g., our ALM activities). In the event of market stress,
these risks could have a material impact on the results of the
Corporation. For additional information, see Interest Rate Risk
Management for Non-trading Activities on page 102.
Our traditional banking loan and deposit products are non-
trading positions and are generally reported at amortized cost for
assets or the amount owed for liabilities (historical cost). However,
these positions are still subject to changes in economic value
based on varying market conditions, with one of the primary risks
being changes in the levels of interest rates. The risk of adverse
changes in the economic value of our non-trading positions arising
from changes in interest rates is managed through our ALM
activities. We have elected to account for certain assets and
liabilities under the fair value option.
Our trading positions are reported at fair value with changes
reflected in income. Trading positions are subject to various
changes in market-based risk factors. The majority of this risk is
generated by our activities in the interest rate, foreign exchange,
credit, equity and commodities markets. In addition, the values of
assets and liabilities could change due to market liquidity,
correlations across markets and expectations of market volatility.
We seek to manage these risk exposures by using a variety of
techniques that encompass a broad range of financial
instruments. The key risk management techniques are discussed
in more detail in the Trading Risk Management section.
A subcommittee has been designated by the MRC as the
primary risk governance authority for Global Markets (Global
Markets, or GM subcommittee). The GM subcommittee’s focus is
to take a forward-looking view of the primary credit, market and
operational risks impacting Global Markets and prioritize those
that need a proactive risk mitigation strategy.
Global Markets Risk Management is responsible for providing
senior management with a clear and comprehensive
understanding of the trading risks to which the Corporation is
exposed. These responsibilities include ownership of market risk
policy, developing and maintaining quantitative risk models,
calculating aggregated risk measures, establishing and monitoring
position limits consistent with risk appetite, conducting daily
reviews and analysis of trading inventory, approving material risk
exposures and fulfilling regulatory requirements. Market risks that
impact businesses outside of Global Markets are monitored and
governed by their respective governance functions.
Quantitative risk models, such as VaR, are an essential
component in evaluating the market risks within a portfolio. A
subcommittee of the MRC is responsible for providing
management oversight and approval of model risk management
and governance (Risk Management, or RM subcommittee). The
RM subcommittee defines model risk standards, consistent with
the Corporation’s risk framework and risk appetite, prevailing
regulatory guidance and industry best practice. Models must meet
certain validation criteria, including effective challenge of the
model development process and a sufficient demonstration of
developmental evidence incorporating a comparison of alternative
theories and approaches. The RM subcommittee ensures model
standards are consistent with model risk requirements and
monitors the effective challenge in the model validation process
across the Corporation. In addition, the relevant stakeholders must
agree on any required actions or restrictions to the models and
maintain a stringent monitoring process to ensure continued
compliance.
For more information on the fair value of certain financial assets
and liabilities, see Note 20 – Fair Value Measurements to the
Consolidated Financial Statements.
Interest Rate Risk
Interest rate risk represents exposures to instruments whose
values vary with the level or volatility of interest rates. These
instruments include, but are not limited to, loans, debt securities,
certain trading-related assets and liabilities, deposits, borrowings
and derivatives. Hedging instruments used to mitigate these risks
include derivatives such as options, futures, forwards and swaps.
Foreign Exchange Risk
Foreign exchange risk represents exposures to changes in the
values of current holdings and future cash flows denominated in
currencies other than the U.S. Dollar. The types of instruments
exposed to this risk include investments in non-U.S. subsidiaries,
foreign currency-denominated loans and securities, future cash
flows in foreign currencies arising from foreign exchange
transactions, foreign currency-denominated debt and various
foreign exchange derivatives whose values fluctuate with changes
in the level or volatility of currency exchange rates or non-
U.S. interest rates. Hedging instruments used to mitigate this risk
include foreign exchange options, currency swaps, futures,
forwards, and foreign currency-denominated debt and deposits.
Mortgage Risk
Mortgage risk represents exposures to changes in the values of
mortgage-related instruments. The values of these instruments
are sensitive to prepayment rates, mortgage rates, agency debt
ratings, default, market liquidity, government participation and
interest rate volatility. Our exposure to these instruments takes