Vision 2014: CCAR Loss Forecasting - Learn What You Are Up Against

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Using research and case studies, we will provide detailed insight on CCAR Loss Forecasting, assessing best practices, methodologies and ranking among peers.

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Vision 2014: CCAR Loss Forecasting - Learn What You Are Up Against

  1. 1. ©2014 Experian Information Solutions, Inc. All rights reserved. Experian and the marks used herein are service marks or registered trademarks of Experian Information Solutions, Inc. Other product and company names mentioned herein are the trademarks of their respective owners. No part of this copyrighted work may be reproduced, modified, or distributed in any form or manner without the prior written permission of Experian. Experian Public. CCAR Loss Forecasting — learn what you are up against Jeff Meli Experian John Taylor Experian #vision2014
  2. 2. 2©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. Work smart and hard… Don’t look where you fell, look where you slipped. – African proverb
  3. 3. 3©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. Work smart and hard… Then you can stand and challenge uncertainty!
  4. 4. 4©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public.  CCAR as more than a “regulatory checkmark”  Risk parameter sensitivity and stress testing  Integrating CCAR activities into risk appetite decision process Session overview
  5. 5. 5©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. CCAR is more than a regulatory checkmark
  6. 6. 6©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. What do you do with this knowledge is of paramount importance! From a micro prudential perspective, the CCAR provides a structured means for supervisors to assess not only whether banks hold enough capital, but also whether banks are able to rapidly and accurately determine their risk exposures, an essential element of effective risk management. The cross-firm nature of the stress tests also helps supervisors identify outliers—both in terms of results and practices—that can provide a basis for further, more targeted reviews. – Chairman Ben Bernanke, 2013
  7. 7. 7©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. Comprehensive Capital Analysis and Review (CCAR) from the Fed…  Enhanced requirement for Loss Forecasting Models, testing/validation and data  Should be macroeconomic dependent under regulatory stress scenarios  Enable forward looking capital planning and account for unique risks  Using outcomes for risk appetite decisions is prudent CCAR Loss Forecasting and stress testing should inform risk appetite CCAR administration realities…  Banks strive to meet minimum required capital under loss forecasting regulatory stress scenarios only  CCAR process can be disconnected from risk appetite setting by business’  CCAR components like stress testing and risk parameter sensitivity of loss forecasts should be more than “regulatory box checking”
  8. 8. 8©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. Large U.S. banks are mandated to undergo stress testing and often asked to demonstrate an ability to understand expected loss model parameter sensitivity for loss forecasting estimates  For the Fed’s annual Comprehensive Capital Analysis and Review (CCAR) exercise, regulator establishes downside parameters and runs its own stress tests ► Banks must meet a 5% equity-to-risk-based-assets test under severe stress scenarios ► Not all scenarios are “likely” but some should be incorporated into future risk appetite decisions  Risk parameter sensitivity testing ► Used to identify highly sensitive risk segments ► Used to determine highly sensitive risk segment impact to risk appetite limits CCAR related regulatory activities for risk management
  9. 9. 9©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. Loan-level models have gained more favor in recent years across banks, etc.  Greater accuracy in prediction with more granular data  Ability to incorporate macroeconomic factors for stress testing  Trade-off against model complexity  Disaggregation to an appropriate level of data granularity and ability to estimate portfolio performance with a variety of portfolio segmentations  Fed CCAR model’s general approach: loan-level PD transition models and LGD models including loan level CCAR foundation best served with loan level models (bottom-up foundation) EAD EL PD Aggregated to portfolio segments and total LGDLoss given default Exposure at default Expected loss Probability of default
  10. 10. 10©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. Using risk parameter sensitivity analytics
  11. 11. 11©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. What should you know? Some important terminology…  Risk parameter sensitivity: analysis to measure the volatility of certain portfolio risk segments from changes in PD and LGD  K calculation: formula used by regulators to calculate capital for various portfolios  Enterprise risk appetite: boundary of risk taking in terms of key metrics such as loss taking capacity and profitability volatility that ensure appropriate return for risk
  12. 12. 12©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. Risk parameter sensitivity planning Identify risk segments most sensitive to future capital increase and lower profitability…  Use “K” capital requirements formula with stressed values from base and stressed scenarios  Assess adequate return hurdles necessary for “likely” stressed scenarios  Determine segmented appropriate risk appetite for highly sensitive risk segments  Avoid what could be coming by actively leveraging your stress scenario estimates within risk and business decision
  13. 13. 13©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public.  Identify PD and LGD segments  Calculate baseline capital metrics Risk parameter sensitivity planning Segment Balance ($) Baseline Capital ($) Capital ($) / Balance ($) 1 $139,465,330 $17,737,960 12.72% 2 $94,182,964 $5,278,842 5.60% 3 $121,980,070 $5,670,736 4.65% ---- ---- ---- ---- 16 $68,780,484 $7,953,062 11.56% Portfolio $2,839,862,934 $188,539,350 6.64%
  14. 14. 14©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public.  Identify PD and LGD segments  Calculate baseline capital metrics Risk parameter sensitivity planning Segment Balance ($) Capital ($) Baseline PD Segment Δ Capital ($) 1 $139,465,330 $17,737,960 0.06% $744,474 2 $94,182,964 $5,278,842 0.08% $220,120 3 $121,980,070 $5,670,736 0.13% $233,572 ---- ---- ---- ---- ---- 16 $68,780,484 $7,953,062 5.06% 257,752 Portfolio $2,839,862,934 $188,539,350  Make segment-level adjustments  Calculate impact on capital requirements
  15. 15. 15©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public.  Call out segments with greatest capital impact and sensitivity to metrics  Strategic action can then be taken on these segments Risk parameter sensitivity planning Segment Balance ($) Capital ($) Baseline PD Δ Capital ($) Δ Capital (%) Elasticity Capital Share (%) Δ Capital Share 1 $139,465,330 $17,737,960 0.06% $744,474 4.20% 0.839 5.69% 3.96% 2 $94,182,964 $5,278,842 0.08% $220,120 4.17% 0.834 1.69% 4.10% 3 $121,980,070 $5,670,736 0.13% $233,572 4.12% 0.824 1.82% 4.04% 14 $329,125,756 $24,448,296 3.10% $846,344 3.46% 0.692 7.78% 3.19% 15 $225,190,822 $19,006,946 3.84% $641,158 3.37% 0.675 6.05% 3.17%
  16. 16. 16©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. Integration of CCAR and risk appetite within business strategy
  17. 17. 17©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. Regulatory requirements and review recommendations Integrating CCAR Loss Forecasting into the bank’s risk appetiteCredit cards Unsecure loans Mortgage loans Auto loans Customerchannelinterfaceprocesses Sensitivity analytics Loan level PD, LGD EAD models Scenario analysis Stresstestscenarioadministration Regulatorprovidedcase Given severity Given scenario Minimum capital requirements Loss forecasting stress testing methodologies Business actions Results output
  18. 18. 18©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. Integrating risk appetite into business operations Finance functions Risk management functions Regulatory capital (or economic cap)  Profitability calculations  Growth return hurdles  Cost of funds by product  Future earnings volatility Remove barriers between finance and risk to integrate required regulatory activity and output into business operations Business lending return hurdles informed from capital can be used to migrate portfolio risk taking creating stable earnings over time Enterprise risk appetite Business and strategic goals Stress testing and risk parameter sensitivity analytics Risk adjusted return on capital (RAROC) Best case: ERA, stress testing and parameter sensitivity can be applied to more than capital planning, but return hurdles as well
  19. 19. 19©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public.  Leverage industry best practices... by using loan level models for loss forecasting that can be leveraged across business activities  Leverage risk parameter sensitivity... to identify high volatility segments based on “likely” macroeconomic stress scenarios  Actively manage risk appetite... by integrating knowledge of sensitive risk segments into business planning and risk appetite setting strategic processes cross-functionally  Look forward... by proactively using CCAR Loss Forecasting to make future lending decisions The business benefits
  20. 20. 20©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. For additional information, please contact: Jeff.Meli@experian.com John.Taylor@experian.com Hear the latest from Vision 2014 in the Daily Roundup: www.experian.com/vision/blog @ExperianVision | #vision2014 Follow us on Twitter
  21. 21. 21©2014 Experian Information Solutions, Inc. All rights reserved. Experian Public. Visit the Experian Expert Bar to learn more about the topics and products covered in this presentation.

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