Bank of America 2015 Annual Report Download - page 92

90 Bank of America 2015
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 $646
million at December 31, 2015, an increase of $118 million from
December 31, 2014 with the increase attributable primarily to
higher unfunded commitments.
Market Risk Management
Market risk is the risk that changes in market conditions may
adversely impact the value of assets or liabilities, or otherwise
negatively impact earnings. 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
95.
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.
Global 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 Management Risk Committee (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
several forms. First, we trade and engage in market-making
activities in a variety of mortgage securities including whole loans,
pass-through certificates, commercial mortgages and
collateralized mortgage obligations including collateralized debt
obligations (CDO) using mortgages as underlying collateral.
Second, we originate a variety of MBS which involves the