RBS 2011 Annual Report Download - page 233

RBS Group 2011 231
Amore appropriate time series for the Dutch RMBS portfolio was
adopted to better reflect the risk in the portfolio as more granular data
became available. In addition, collateralised based discounting has been
implemented for the vast majority of the collateralised positions in place
of the previous LIBOR-based discounting approach.
Following the implementation of CRD III, three new models - for stressed
VaR, incremental risk charge and all price risk (see more below) - have
been fully approved by the UK regulator and form part of the capital and
risk management framework from 31 December 2011 onwards.
Basel 2.5 (CRD III)*
The aim of CRD III is to improve the financial strength of institutions by
increasing the financial resources required against certain risks in the
trading book.
The Group is required to calculate: (i) an additional capital charge based
on a stressed calibration of the VaR model - stressed VaR; (ii) an
incremental risk charge to capture the default and migration risk for credit
risk positions in the trading book; and (iii) an all price risk measure for
correlation trading positions, subject to a capital floor that is based on
standardised securitisation charges.
The capital charges associated with these new models at 31 December
2011 are shown in the table below:
Total
£m
Stressed VaR 1,682
Incremental risk 469
All price risk 297
All other aspects of the CRD III rule changes have also been
implemented.
Pricing models
Pricing models are developed and owned by the front office. Where
pricing models are used as the basis of books and records valuations,
they are subject to oversight and approval by asset level modelled
product review committees (ALMPRCs). These committees prioritise
models for independent validation by Group Risk Analytics (GRA) taking
into consideration both the materiality of risk booked against the model
and an assessment of the degree of model risk (i.e. valuation uncertainty
arising from choice of modelling assumptions). The GRA review aims to
quantify model risk by comparing model outputs against those of
alternative independently developed models, the results of which are
used by Market Risk to inform risk limits and by Finance to inform model
reserves.
In 2011, updated Group Standards for the development, testing and
validation of derivative pricing models were agreed and implemented.
Revisions to the model validation framework ensure that all new models
and model changes are reviewed by Market Risk and Finance and,
subject to materiality, independently validated by GRA. Model
governance is through the ALMPRCs, which are newly established sub-
committees of the overall GBM Modelled Product Review Committee
(previously called the Group Model Product Review Committee).
Stress testing
The Group undertakes daily stress testing to identify the potential losses
in excess of VaR. Stress testing is used to calculate a range of trading
book exposures which result from extreme market events. Stress testing
measures the impact of exceptional changes in market rates and prices
on the fair value of the Group’s trading portfolios. The Group calculates
sensitivity analysis, historical stress tests and bottom-up stress testing.
Sensitivity analysis measures the sensitivity of the current portfolio of
positions to defined market risk factor movements. These stresses are of
asmaller magnitude compared to historical or bottom-up stress testing
and are subject to the Group Market Risk limit framework.
Historical stress tests calculate the changes in the portfolio valuations
that would be generated if the market movements that occurred during
historical market events were repeated.
Bottom-up stress testing is based on analysing the market risk exposures
by risk factors and stressing each risk factor based on consultation with
risk managers, economists and front office. The tests may be based on
an economic scenario that is translated into risk factor shocks by an
economist or by risk managers and front office as a means of assessing
the vulnerabilities of their book.
The Global Market Risk Stress Testing Committee reviews and discusses
all matters relating to market risk stress testing. Stress test exposures are
discussed with senior management and relevant information is reported
to the Group Risk Committee, the ERF and the Board. Breaches in the
Group’s market risk stress testing limits are monitored and reported.
In 2011, the market risk stress testing framework was further developed
and enhanced. Reverse stress testing has been implemented, which is
designed to assess the plausibility of stressing market risk factors until
the loss reaches a given threshold.
In addition to VaR and stress testing, the Group calculates a wide range
of sensitivity and position risk measures, for example interest rate ladders
or option revaluation matrices. These measures provide valuable
additional controls, often at individual desk or strategy level.