Enterprise Risk Management at ABN AMRO

            

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Themes: -
Period : 2003
Organization : ABN AMRO
Pub Date : 2003
Countries : Global
Industry : Banking

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Case Code : ERMT-023
Case Length : 19 Pages
Price: Rs. 300;



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Market Risk

Market risk was the possibility of movements in financial markets changing the value of the bank's trading portfolios. Market risk arose from the bank trading on behalf of clients and on its own account. In trading activities, risk arose both from open (unhedged) positions and from imperfect correlations between market positions that were intended to offset one another. ABN AMRO measured and monitored different market risk factors such as interest rate sensitivity, open currency position, stock prices, spread sensitivities, greeks (delta, gamma, vega, rho). In addition, ABN AMRO calculated and set limits for VAR, stress tests, scenario analysis, position concentration and ageing. Market risks were monitored at different levels, starting from single trading portfolios to key aggregation levels.

Internal models met regulatory requirements and were approved by the Dutch central bank for the calculation of solvency requirements for market risk. ABN Amro used VAR as the primary tool for day-to-day monitoring of trading-related market risk. VAR was calculated by Historical Simulation, based on four years of historical data. The bank used a one-day holding period, relative changes of historical rates and prices, a 99% confidence level and equally weighted simulations. The VAR was reported daily to the senior management of the BUs, GRM and members of the Managing Board.

The effectiveness of VAR was assessed by back testing, which counted the number of days when the losses were bigger than the estimated VAR figure. Theoretically, with a 99% confidence level, it was expected that on one out of every 100 trading days a loss which exceeded the VAR might occur. The back testing was performed on the actual profit and loss (P&L) and a hypothetical P&L, which measured a P&L on market risk exposure against movements of financial market prices and excluded effects of commissions, origination fees and intra-day trading. The results of the back testing on the actual and the hypothetical P&L were regularly reported to the Dutch central bank. The hypothetical back testing was also an essential instrument for validation of the bank's internal models. The back-testing result showed that the hypothetical P&L exceeded the calculated VAR only on two days in 2002. This was within model expectations. Extraordinary events, for example July-October 1998, in the historical data, along with certain conservative assumptions made when aggregating risk factors, had led to a relatively conservative VAR estimate.

The VAR measure was supplemented by a series of stress tests and scenario analyses, which shed light on the behavior of a portfolio under extreme market events. Stress tests had been developed internally to reflect specific characteristics of the bank's portfolios, while scenarios were based on historical market events, like the financial markets crisis of July-October 1998. Both stress tests and scenario analyses were performed daily for each trading portfolio and at several aggregation levels, including the bank-wide total.

Group Asset and Liability Management (GALM) protected the earnings and capital position of the bank from adverse interest rate and currency movements and managed the bank's liquidity. The Group Asset Management and Liability Committee (Group ALCO), whose members were drawn from finance, treasury and risk management, had global responsibility across the SBUs. It also monitored the activities of local asset and liability management committees in the bank's home markets. ALCOs existed in other countries, but their interest risk came under the market risk management framework monitored by GRM.

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