This document outlines a framework for estimating capital requirements against event risk. It discusses key components such as a mapping module to map exposure to locations, an impact module to determine loss assumptions from events, and a simulation module to generate scenarios and estimate loss distributions. The mapping module uses geographical and other data to analyze exposure. The impact module is built on historical loss data. The simulation module uses Monte Carlo simulations to model extreme event outcomes and losses. The goal is for the framework to conceptually mimic the relationship between events and portfolio losses based on factors like location and industry.

1. Framework for Estimating the Capital against Event Risk
Oct 2014

2. Agenda
► Framework for Estimating the Capital against Event Risk

3. Agenda
► Framework for
► Estimating the
► Capital against
► Event
► Risk

4. Agenda
► Event
► Risk
► Capital
► Estimating
► Framework

5. Event

6. Event
► What do we mean by an ‘event’?

7. Event
► What do we mean by an ‘event’?
► What type of events?

8. Event
► What do we mean by an ‘event’?
► What type of events?
► Good or Bad?

9. Event
► What do we mean by an ‘event’?
► What type of events?
► Good or Bad?

10. Event

11. Event
► Earthquake
► Landslide
► Cloud burst
► Floods
► Cyclone
► Drought
► Tsunami

12. Event
► Earthquake
► Landslide
► Cloud burst
► Floods
► Cyclone
► Drought
► Tsunami
► Terrorist attack
► Social unrest
► Industrial
accident
► Epidemics
► Livestock
epidemics
► Regulatory
change
► Government
change
► Labour strike
► Anna Hazare

13. Event
► Earthquake
► Landslide
► Cloud burst
► Floods
► Cyclone
► Drought
► Tsunami
► Terrorist attack
► Social unrest
► Industrial
accident
► Epidemics
► Livestock
epidemics
► Regulatory
change
► Government
change
► Labour strike
► Anna Hazare
► Fermentation!
► Airplanes
► Wireless
technology
► Google!
► email
► Facebook
► Twitter

14. Event
► Earthquake
► Landslide
► Cloud burst
► Floods
► Cyclone
► Drought
► Tsunami
► Terrorist attack
► Social unrest
► Industrial
accident
► Epidemics
► Livestock
epidemics
► Regulatory
change
► Government
change
► Labour strike
► Anna Hazare
► Fermentation!
► Airplanes
► Wireless
technology
► Google!
► email
► Facebook
► Twitter

15. Event
► Earthquake
► Floods
► Cyclone
► Drought

16. Risk

17. Risk
► What is risk?
► A quick search on web throws the following results:
► a situation involving exposure to danger
► the possibility that something unpleasant or unwelcome will happen
► a person or thing regarded as a threat or likely source of danger
► a possibility of harm or damage against which something is insured
► a person or thing regarded as likely to turn out well or badly in a
particular context or respect
► the possibility of financial loss

18. Risk
► Earthquake
► Floods
► Cyclone
► Drought

19. Risk
► Earthquake
► Floods
► Cyclone
► Drought
► Where is the risk coming from?

20. Risk
► Earthquake
► Floods
► Cyclone
► Drought
► Where is the risk coming from?
► Scale
► Action
► Timing

21. Risk
► Earthquake
► Floods
► Cyclone
► Drought
► Where is the risk coming from?
► Scale: Who?
► Action: How?
► Timing: When?

22. Risk
► Earthquake
► Floods
► Cyclone
► Drought
► Where is the risk coming from?
► Scale: Who? Mapping, history, report
► Action: How?
► Timing: When?

23. Risk
► Earthquake
► Floods
► Cyclone
► Drought
► Where is the risk coming from?
► Scale: Who? Mapping, history, report
► Action: How? Geology, hydrology, history
► Timing: When?

24. Risk
► Earthquake
► Floods
► Cyclone
► Drought
► Where is the risk coming from?
► Scale: Who? Mapping, history, report
► Action: How? Geology, hydrology, history
► Timing: When? Rocket Science, astrology!

25. Capital

26. Capital
► Capital here means the amount a business or company should have to
sustain the risks it takes on in the line of business

27. Capital
► Capital here means the amount a business or company should have to
sustain the risks it takes on in the line of business
► Example
► A lending firm ABC that faces the risk of losing 20% of its portfolio in a
year due to credit risk should maintain at least the following proportion
of its assets as networth:
(a) 10%
(b) 15%
(c) 20%
(d) 25%

28. Capital
► Capital here means the amount a business or company should have to
sustain the risks it takes on in the line of business
► Example
► A lending firm ABC that faces the risk of losing 20% of its portfolio in a
year due to credit risk should maintain at least the following proportion
of its assets as networth:
(a) 10%
(b) 15%
(c) 20%
(d) 25%
(Assume that bank faces only one type of risk, i.e. credit risk!)

29. Capital
► Capital here means the amount a business or company should have to
sustain the risks it takes on in the line of business
► Example
► A lending firm ABC that faces the risk of losing 20% of its portfolio in a
year due to credit risk should maintain at least the following proportion
of its assets as networth:
(a) 10%
(b) 15%
(c) 20%
(d) 25%
(e) There is a problem with the question
(Assume that bank faces only one type of risk, i.e. credit risk!)

30. Capital
► Capital here means the amount a business or company should have to
sustain the risks it takes on in the line of business
► Example
► A lending firm ABC that faces the risk of losing 20% of its portfolio in a
year due to credit risk should maintain at least the following proportion
of its assets as networth:
(a) 10%
(b) 15%
(c) 20%
(d) 25%
(e) There is a problem with the question
(f) Depends
(Assume that bank faces only one type of risk, i.e. credit risk!)

31. Estimation

32. Estimation
► We may not know with certainty, or with 100% confidence, the amount a
company stands to loose due to risks it takes

33. Estimation
► We may not know with certainty, or with 100% confidence, the amount a
company stands to loose due to risks it takes
► So, the capital requirement of ABC ‘depends’ on:
► Unexpected losses at different levels of certainty
► Credit rating ABC is aspiring for
► A loss distribution may help here!

34. Framework

35. Event risk and loss
► The framework to estimate capital against the event risk should conceptually mimic the
relationship between the ‘event’ and the ‘portfolio loss’
► However this relationship in turn depends on several factors
Event
Portfolio
Loss

36. Event risk and loss
► The framework to estimate capital against the event risk should conceptually mimic the
relationship between the ‘event’ and the ‘portfolio loss’
► However this relationship in turn depends on several factors
Event
Portfolio
Loss
Geographical Exposure
Location Vulnerability
Underlying Industry
Underlying Asset Class
Risk Mitigants

37. Framework
► The current framework is designed to keeping in mind different linkages between the
event and the resulting portfolio loss
► The key components of the framework are:
► Mapping Module: This module maps the rupee exposure and other factors like
location vulnerability and industry clusters to geographies at a granular level. This
module is developed in R using the Google APIs.

38. Mapping Module: Area of Influence
► The function getArea(“location”, radius of influence) gives us details for a location
(say, Vadodara) in an area of influence defined by the radius in kms (say, 100 kms)
Exposure
Pockets MSME Clusters

39. Framework
► The current framework is designed to keeping in mind different linkages between the
event and the resulting portfolio loss
► The key components of the framework are:
► Mapping Module: This module maps the rupee exposure and other factors like
location vulnerability and industry clusters to geographies at a granular level. This
module is developed in R using the Google APIs.
► Impact Module: The output of this module is the loss assumption of a given event
for a given asset class. This module is being built on the repository of historical data
on impact due to risk events and the knowledge gathered through primary and
secondary research by the risk team.

40. Impact Module: Earthquake on Income Source

41. Framework
► The current framework is designed to keeping in mind different linkages between the
event and the resulting portfolio loss
► The key components of the framework are:
► Mapping Module: This module maps the rupee exposure and other factors like
location vulnerability and industry clusters to geographies at a granular level. This
module is developed in R using the Google APIs.
► Impact Module: The output of this module is the loss assumption of a given event
for a given asset class. This module is being built on the repository of historical data
on impact due to risk events and the knowledge gathered through primary and
secondary research by the risk team.
► Simulation Module: This module is the calculation master. Based on the probability
and severity assumptions, the model uses the Monte Carlo simulations to generate
various extreme scenarios and estimate loss distribution

42. Mapping Event Probabilities
► How do we get event probabilities?

43. Mapping Event Probabilities
► Probabilities associated with different risk
events are mapped to different geographic
locations based data released by the
Ministry of Home Affairs, National Disaster
Management department
► Drought Map is based on the data
provided by the IMD Pune’s Drought
Research Unit
Earthquake Map
Flood Map Cyclone Map Drought Map

44. Simulating Events
► Based on the historical records, number
of events over the next one year horizon
are generated
► Geographic locations are selected based
on the associated probabilities from
hazard maps
► Associated loss for each of this events are
estimated based on Loss Matrix
► Earthquake
► Cyclone
► Floods
► Droughts

45. Concluding Remarks

46. Some Remarks
► It’s difficult to estimate the capital requirement against such risks
► Assumptions for probability of event and severity of loss-given-event should be refined on a
continuous basis as we receive new data
► Mitigants like insurance play an important role
► Anecdotal evidence may provide useful insights into how extreme events impact borrower
behaviour and portfolio performance

47. Thank you!